How to calculate your Risk Appetite ?



Risk Appetite

A friend of mine while reading a handbook on "How to make money by investing in Stock Markets", came across a formula for calculating the quantum of money which should be invested in equities. The formula was - "Percentage of asset allocation in equities = 100 - your age". As soon as he read this formula, he called me up and asked "suppose, if my age is 30, i should invest 70% (100-30) of my investable surplus in equities, but if my age is 70, should i still invest 30% in equities?" If we consider the given formula, his question was mathematically perfect. but if we think practically, will a person who has already retired at the age of , say 60 years, invest 30% of his hard earned savings into equities at the age of 70? In most of the cases, the answer will be NO. So, is the formula wrong? Partially YES. I personally feel that the formula should be slightly modified to suit our needs. So here is a new revised formula " Percentage of asset allocation in equities = (Your retiring age - Your present age)/Your retiring age". Let us again take up my friends problem and try to find a solution by putting the values in the revised formula. Now, if your age is 30 years and you are expecting to retire at the age of 60, then, the allocation of assets towards equities should be 50% [(60-30)/60]. Moving further, if you are 50 years old, your allocation should be around 20% and if you are at60, then in that case you should avoid investing in equities, until and unless you have been bitten by the dalal street bug.This is simply because of the fact that after retirement, your in flows of cash will almost remain constant over years, but your outflows will continue to soar due to rising living expenses and medical costs. Investments by persons in that age bracket should be focused to minimize the risks, maximize the returns and at the same time, preserve the capital. However, the younger you are, higher is the ability and willingness to take risks. It is very essential to identify the risk appetite at the earliest and then take a call on investment decisions.This risk appetite should be calculated on the basis of a person's working age. One should design a proper investment strategy and asset allocation plan only after considering his ability and willingness to take risks. the exact allocation towards equities may vary from person to person due differences in risk appetite and availability of investable surplus, but the above mentioned formula gives us a funda that "Risk appetite is inversely proportionate to our age". So friends, start investing wisely at the earliest, because, MONEY MATTERS




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4 Respones to "How to calculate your Risk Appetite ?"

Danyal said...

Wow...Mr Nsquare...you seem to be a genus in money matters...i wish you all the best for your endeavour in this risky field and wish you all the success...keep it up..I hope to to appoint you as my tax consultant one day...please sir dont say no...tc


July 6, 2010 at 12:09 AM
N square said...

Thanks a lot Mr. Danyal


July 7, 2010 at 1:40 AM
Ivan said...

if older people should invest more in high risk investment, don't you consider his health as a risk? if he gets health problem because he is shocked with his lost investment, the risk becomes higher, doesn't it? please consider this humanity issue.


November 21, 2010 at 10:41 AM
Nandan Narula said...

Thats true Ivan. . i mentoined in the sample problem above that if you are at 60, you can avoid equities. So definitely at a later stage in life when health is not always on your side , you surely need some safety and security in the form of fixed returns and the same thing i ve tried to put up.

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