Investment Portfolios and Risk Tolerance
Risk is the degree of uncertainty or potential downs in the financial market due to the poor performance of an asset class or the market as a whole. The risk tolerance or risk appetite of investors is basically how much the investor is willing to invest and how long can the investor tolerate depending on the volatility of the market. This risk tolerance affects the allocation of funds and financial assets into the investors’ investment portfolio.
There are three types of investor risk tolerance levels, low-risk, moderate-risk, and high-risk. Multiple factors such as nature of income, number of dependents, liquidity requirements, etc have to be considered before deciding in which level a particular investor falls.
Suppose, an investor wants to generate revenue in a short period and avoid the volatility of the market, then this is a level of low risk. This type of conservative investor often builds a portfolio comprising large-cap value stocks, investment bonds, cash equivalents, market index funds, etc.
Whereas, if the investor wants to invest for a longer period, (say more than 15-20 years), and has a higher capacity to hold more market volatility and ups and downs, then it is a case of high-risk tolerance. Here, investors with high-risk appetites focus on investing in the investment portfolio comprising small-cap and large-cap growth stock, high-yield bonds, oil, gold, real estate, etc.
Thus, before investing, you should always understand your risk appetite so that investment doesn’t bring financial stress to your life. The portfolios should be designed in such as way that your risk appetite is properly covered.