INVESTMENT of nearly all types carry
some amount of risk. And it varies from investor to investor. Several
factors, like age of the investor, income level, number of people
financially dependent on him/her, net worth and mindset to withstand any
loss, etc determine individual risk tolerance levels. Given these conditions, different investors are comfortable with different levels of risk. According to Suresh Sadagopan, founder, Ladder7 Financial Advisories, risk tolerance is a completely behavioural aspect for individuals. "Some people are fine with the market price of their investments falling below their purchasing price, while some are not tolerant to such a situation," Sadagopan said.
Judging the risk tolerance of each investor is important because often while setting their financial goals, investors overestimate or underestimate their risk tolerance level. But it is always important for investors to invest according to their goals.
"Often, it is seen that the goals for an investor are aggressive while he does not have the risk appetite. In such situations, it is important to temper down the goals so that as risks are lowered, the goals are also reduced," Sadagopan said.
Another situation that financial planners face is when an investor has aggressive goals but the individual's expenses are also on the higher side. "In such situations, we tell clients that if the goals are aggressive and they have high amount of savings, then the goals can be achieved," Sadagopan said.
Financial planners, while helping a new investor plan hisher life's financial goals, ask some questions to get an idea about the risk taking ability of the person, financial goals and the kind of aggressive investment portfolio the individual should have to reach those financial goals.
According to a top official at a domestic fund house, "The first part of the questionnaire captures the personal information in order to integrate the invested assets in the overall financial plan.The next part is used to determine the investment horizon.The client's risk-taking ability is checked by asking for events in which he would need to get the invested money back. The next part is regarding risk awareness and the client's aspiration level.Finally, there are questions that try to elicit the client's intensity for loss aversion," the official said.
Several readymade tests are available for financial planners to judge the risktaking ability of their prospective clients. They are aimed at judging the reaction of the investor in differ ent situations relating to their investment. The answers to those questions give financial planners some idea about the risk tolerance levels of investors.
According to Sadagopan, FinaMetrica (FinaMetrica Risk Tolerance Test) is one of the best available tests in the market. It is a psychometric test designed by the School of Psychology at the University of New South Wales, Australia and is used widely. Like in this test, all questionnaires are aimed at judging the risk tolerance levels of investors and have multiple choice questions.These are based on historical studies or observations about how investors react to different situations relating to their investments.
Apart from the general questions about annual income, age, the number of dependents, etc, often financial planners will give the investor a situation where there are various situations of loss, which is balanced out by equally highlow levels of gains. The investor would need to answer what kind of loss he/she is willing to take for a chance to win a commensurate amount of gains on hisher investments. There are also questions about insurance, investor's own perception about risk tolerance level, etc (see graphic).
Financial planners and advisers say that before visiting a planner or an adviser or the first time, it is always better to go through some of sample questionnaires so that you are aware of the kind of questions that you may face during your meeting with your planner adviser.
praveen sharma
pgdm 3rd sem
source -TOI
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