Goals, investment horizon, returns, liquidity, risk appetite, etc., are vital in retirement planning. Of all these factors, risk-taking capacity could be the hardest to weigh as it involves individual scenarios and personality traits that may vary from person to person. Still, one cannot ignore the aspect of risk appetite, something that requires balancing madness and sanity.

According to the Financial Stability Board (FSB), an international body that monitors risks of global financial systems, risk appetite is the aggregate of risks a financial institution is willing to take to achieve its strategic objectives and business plans. However, in the personal finance space, it is the risk an individual is ready to take to achieve goals.

How Can You Know Your Risk Appetite?

According to Anuj Kesarwani, a certified financial planner, chartered trust and estate planner, and founder of Zenith Finserve, “Risk appetite can be measured in numbers through questionnaires. Answers to each question have a score attached to it and the aggregate score is used to assign a final risk profile: conservative, moderate, or aggressive. Numerical measurements should be used as a complementary tool rather than the sole determinant of an individual’s risk appetite as qualitative factors are also involved. Additionally, risk appetite can change over time based on experiences, life events, and shifts in financial goals.”

Kesarwani says, there are three parts to risk appetite: risk required (to achieve one’s goal), risk capacity (age and other measurable factors), and risk tolerance (personal traits and choices).

While there is no standardized risk-mapping metric, financial advisors use their metrics to assess investors’ risk profiles and advice—like a doctor asking questions, diagnoses, and treats. Some financial institutions, too, have questionnaires and investors can learn about their risk appetite by answering them; however, they should approach it cautiously—like self-diagnosis. 

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Relation Between Risk Appetite And Retirement Planning

People close to retirement generally do not prefer taking risks. However, it is not always the case as it can change with time.

Says Kesarwani, “The risk appetite of a person financially prepared for retirement is generally more than the one who is not. One who has limited funds will naturally focus towards preservation of existing corpus over taking investment risk to generate more returns.”

Also, risk taking capacity may vary between a salaried person and a self-employed person.

Which Factors Influence Risk Appetite?

Age: Age can be a vital factor in gauging risk profile; it assumes that most responsibilities have been handled, assets have been created, and a certain level of financial stability has been achieved. However, there are other factors to assess risk appetite. 

Accumulated Corpus And Financial Security: The accumulated corpus or inherited assets provide security. A person from this background would be more willing to take risks than someone without financial security. So, it is not just age but financial stability.  

Cash Flow: The assurance of consistent cash flow for life can turn a person from a moderate to aggressive investor. The fear of losing savings or having no income source in old age can turn people risk-averse as soon as regular cash flow stops.   

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Financial Responsibilities: If there are family responsibilities, one would not be willing to make random investments and put everyone at risk. However, risk-taking capacity would increase if they have fulfilled the responsibilities.  

Personal Traits And Psychological Factors: Personal traits, conditioning, and psychological factors are critical. Someone who had invested in the stock market in 2021 after the Covid-19 pandemic would be more willing to take risks in equities than someone who had invested in 2018 and lost money in 2020 in the pandemic with looming uncertainty and no predictable future. 

Finally, risk appetite is the outcome of many factors. Consider how much risk you need to take to achieve goals based on your earnings and circumstances, and reflect on why you prefer one choice over the other.