How the pandemic-hit market can show you your actual risk appetite

Mutual Fund Investment

How the pandemic-hit market can show you your actual risk appetite

By Aniket Tamboli · · 9 min read

The economic uncertainty caused by the COVID-19 lockdown has spooked investors and straight-up KO’d markets. For the first time in a decade, we’re witnessing a full-blown bear market.

To put things into perspective – in 2008, markets fell 60% in 8 months; in 2020, they’ve fallen over 40% in 15 days! If all this is making you question your risk tolerance, you’re not alone.

Even if you “aren’t into investing,” watching your Rs.1L worth of SIP investments show up as ~Rs.62.7k is going to jolt you awake. So here’s some food for thought – should you have questioned yourself the same way when you first made the investment?

Look back to the time when you filled a risk assessment survey on your investment portal. It probably told you that you’re a “moderately aggressive” investor. What did that really mean then and how do you feel about that assessment now?

“Risk? I like to live dangerously haha.”

Cool it, Austin Powers. If you’re like most people, you invest as a way to secure your future and actually meet your goals and aspirations. But you’re dealing with hard-earned money; and while a large part of your decisions might be very rational, it is important to pay attention to your comfort-level with taking risks.

Investments across different classes have different risk-return grades. Each person has a different risk tolerance, which depends on several factors – like your short- and long-term goals, age and life-stage, income stability, and savings to name a few.

Accurately understanding your risk tolerance can help you deal with rude shocks when the numbers fall (like they are right now). Will it hurt any less? Probably not. But, will you have a cushion because you factored in this possibility? Definitely yes.

“What would you do if the markets fell by 25%”

The most commonly used method of gauging risk appetite are questionnaires that evaluate responses to hypothetical market scenarios. However, the method isn’t without its criticisms – like that it’s a one-time activity and over-relies on psychometrics. Perhaps its biggest deficiency, though, is estimating loss-tolerance. During good times, we tend to be complacent and underestimate how much “downside” we can withstand. 

If you assessed your risk tolerance during sunnier days, chances are you overestimated it. Unfortunately, no one can know precisely what their tolerance for financial loss is until they hit said tolerance. You think babies are adorable right up until one throws up on you after a really long day at work.

That’s where a good financial advisor can come in. (Focus, we’ve moved on from the baby) Through in-person discussions, experienced planners gauge softer aspects like loss-aversion and anxiety, by probing deeper into your motives and searching for parallels in your past. Aspects that cannot be assessed through a standard questionnaire.

Problem is, much like a half-hearted mall-security pat-down, risk profiling is often seen as an administrative ‘to-do’ item and nothing more.

As a result, we often end up with portfolios that don’t align with our actual risk profile. And we don’t even realise or question this when the going is good. But when things go south, the effects are painful.

Better late now than never

If you started investing in equity markets in the last 4-5 years, this is probably the first time you’re experiencing a freely-falling market (with the possibility of prolonged lows and losses). Taking that risk assessment survey now will give you a better idea about how much risk and loss you can really tolerate.

These basic questions are a good starting point:

  1. How uncomfortable are you with your portfolio’s performance right now?
  2. How often does it play on your mind? Is it making you overly anxious?
  3. What additional drop in your portfolio value are you ok taking, before you cut your losses?
  4. How much longer will you hold onto your investments, knowing that they will recover at some point in the years to come?

If answers to these questions make you squeamish, maybe you have taken on (or been ill-advised to take) more risk than you’re comfortable with. Now would be a great time to reassess this and course-correct, so that you can deal with the near-term uncertainty and stick to the long-term play.

Don’t worry, none of this is as overwhelming as it might sound. In fact, we have a quick and easy risk assessment test to get you started: 

If your new risk profile is vastly different from your original one, this could be down to multiple reasons, like changing priorities and financial standing, or certain life events. But it’s important to also question your financial advisor’s efficacy in keeping your profile up to date. It’s possible that your profile was incorrect to begin with.

Combine this up-to-date risk profile with a financial advisor (who’s more interested in understanding your goals than cashing your cheques) and you can now assess how you need to diversify your portfolio in the near and long term. What’s more? You can also get in touch with our team for pointers on where to start.

Last but not least – remember to stick by this profile when the next bull market comes along. Just because you lose some right now doesn’t mean you can’t win big in the future!

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