Last Updated on December 17, 2023 at 6:40 am
“I have a long-term investment goal and a moderate risk appetite. Which mutual funds should I select?” This is a query often seen on personal finance forums. We delve into what actions should be taken by investors in such scenarios. However, when asked the seemingly simple follow-up question, “What does a moderate risk appetite entail?” the inquirer is often left puzzled and even offended, with no apparent response.
This is because the concept of ‘risk appetite’ cannot be definitively defined, let alone divided into low, moderate, or high categories. Various costly tools exist, making a profit by selling surveys to financial advisors. Nevertheless, a frank and seasoned financial consultant would likely tell you two things about evaluating an investor’s risk.
First, it’s akin to asking an untrained individual how much of a marathon they could likely finish. Second, one can only understand how an investor will respond to substantial profits or losses after the event.
Offering suggestions to an investor who says, “I am scared of equity”, is relatively easier than self-proclamations of moderate and high-risk appetites. See: for example: How to invest without using mutual funds.
Investors should not be making assumptions about their risk appetite. I only saw my first equity crash after 12 years, and in hindsight, though it seemed steep, the quick recovery has diminished the pride associated with the experience.
My risk appetite has not yet been severely tested. I have no idea how I would react at that time. I have no idea what my risk appetite is. I have no idea what my risk tolerance is. All I know is the risk necessary for my financial goals. This is, however, good enough to manage a portfolio.
Advisors should prioritize evaluating an individual’s risk quotient (RQ) rather than their appetite for risk. Even an uninformed investor may be willing to take high risks, sometimes due to a lack of knowledge. To effectively assess RQ, advisors must possess a commendable RQ themselves. If the practicality of this seems daunting, then it’s wiser for such individuals to manage their investments themselves.
Confused about RQ? Try this: Ask yourself or anyone you know who has invested in equities, like stocks or mutual funds, what returns they anticipate from their investment over the coming 15 years. If the response is a mere percentage, like 12% or 10%, then it indicates their risk quotient is not developed enough to thrive in the equity market.
Why? The spread in max and minimum returns possible from equity over any period – 5 or 15 years – is so large that no one can sit and expect a return. See: Do not expect returns from mutual fund SIPs! Do this instead!
Fact: Returns from equity are uncertain no matter what you do. So a combination of low expectations, suitable investments and systematic portfolio management is necessary and reasonably sufficient to create enough wealth for our future needs.
Judging the proximity of the client’s response to the fact, RQ can be assessed by advisors as, say,
- inadequate to start investing or even provide advice
- amenable to suggestions
- superior = easy to work with (advisor may not be necessary)
Type 1 clients can be directed to simple literature on the “basics”, and types 2 and 3 can be taken on. If a self-assessment is being made, type 1 investors should not be in a hurry to invest.
Apologies if the above discussion wasn’t what you expected, particularly if you were hoping for a list of mutual funds. It’s important to understand that making such recommendations is challenging without understanding your risk tolerance. I can only provide general advice, such as the importance of sufficient equity exposure for long-term objectives.
Regardless of the type of fund you choose – index, aggressive hybrid, balanced advantage, or dynamic asset allocation – they will all experience varying degrees of fall if the market does. For instance, if the Nifty falls by 30% and your fund falls by 20%, I cannot predict your reaction to this decrease, especially when there’s real money at stake.
The impact of a 20% decrease is not simply 10% less than a 30% decrease. Some might have expected their funds to remain stable or decrease less significantly. That’s what makes assessing risk appetite so complex. It’s akin to the relationship between test scores and intelligence.
As a teacher, I can administer a test to measure how well my students meet academic standards, but this doesn’t provide insight into their level of intelligence. Their intelligence cannot be easily measured, nor is it necessary to do so.
To graduate, a student should appreciate the system’s needs and fall in line (no system is without fault, but hey, it is a choice!). Similarly, investors should appreciate their future needs and seek appropriate solutions. They should not get carried away by untested, unsubstantiated opinions of how much loss (or gain) they can stomach.
So what should investors do? Assuming this is for a long-term goal (say 25 years), gradually increase your equity exposure with an index fund. Start with, say, 5%-10% of your monthly investment. Gradually increase it over the next few years. All the time, observe and record how much the fund value fluctuates. Get used to the volatility.
Force yourself to invest a little extra if the market’s monthly return is negative. Force yourself to invest regularly without worrying about the market’s current condition. Limit equity exposure to no more than 50% to 60%. Once you hit this mark, start thinking about how you will manage this risk, in particular, gradually reduce this equity exposure. In the meantime, as per market movements, your ability to handle risk will be tested in real time with real money. There is no other way.
Do share this article with your friends using the buttons below.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
Podcast: Let’s Get RICH With PATTU! Every single Indian CAN grow their wealth!
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter with the form below.
- Hit ‘reply’ to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
Explore the site! Search among our 2000+ articles for information and insight!
About The Author
Dr. M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter, Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu gets a superpower!” is now available!
Most investor problems can be traced to a lack of informed decision-making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it and teach him several key ideas of decision-making and money management is the narrative. What readers say!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. – Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & it’s content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.
Your Ultimate Guide to Travel
This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)