Risk appetite for individual investors in India

Exuberance in stock markets (Sensex), of the type seen recently in India, often leads to individual investors behaving in one of two ways:

• Investing with the herd
• Never finding the right level to enter the market !

Both these outcomes have the potential to be painful for individual investors. When you invest with the herd, you are never really sure if you are picking ‘yesterday’s’ good news and therefore buying at close to peak. On the other hand, if you stay out of a rising market for too long, you are likely to miss out on significant gains. What should an investor do in such a case ?

It comes back to thinking of investment as a long term game and building a diversified asset portfolio that meets your risk appetite as you go through different life stages.

A popular yardstick to understand one’s risk appetite for equities is to measure it as ‘100 – your age’. For example, if you are 40, this yardstick suggests that you can have approximately 60% of your asset allocation in equities. In our opinion this yardstick need not be correct for many investors. Risk appetite is a personal matter and it can vary based on an individual’s situation and age.

Some believe that it is better to have an investment strategy built around how much you are willing to lose as opposed to how much you would ideally like to make. Risk appetite could then be defined as how much of value you would be ready to lose over short /medium term (up to 3 years). If the answer is 40 to 50%, then you obviously have a high risk appetite and are investing for the longer term (e.g. 10 years). In such a case, a relatively higher proportion of riskier assets that can outrun inflation by a significant amount could make sense. Investments in stocks, particularly in emerging technologies, mid caps, etc could give you the upside in such situations.

However, if you are willing to lose no more than say 10 to 15% of your investments’ value over the short/medium term, then you can be classified as a risk averse investor who could be better off with more ‘secure’ investments like bank deposits, etc.

If you have the heart to lose between 15 to 40% of your investment value over the short/medium term, you could be classified as a moderate risk investor. In such cases, your portfolio could contain balanced mutual funds that diversify your risks and have about 65% of their assets in equity, the rest being in ‘safer’ instruments.

Please recognise that the investment percentages talked about above are primarily for liquid assets – i.e. do not include property which typically forms a large portion of many investors’ portfolios. Also, the risk appetite percentages of 10-15%, 15-40% and 40-50% are indicative.

We will talk about what a typical portfolio might look like for these three investor classes in a subsequent article.