While making investments, there are two factors which affect our decisions with respect to taking risks. It is important to understand our Willingness vs Ability to take risk.
Ability to take risk – This measure tells us how much of risk can be taken by us while making an investment decision.
Willingness to take risk – This is more subjective measure, which tells how “Risk averse” we are as an investor.
Let’s look at some factors which affect your ability to take risk, most of them are really self explanatory.
- You age – Older I get, the lesser my chances to course correct – so generally ability to take risk reduces with age.
- Present financial status – Better financial status, more risk we can take for the future.
- Criticality of the goal – If the goal is very important, we cannot afford more risk
- Stability of earnings – If we know how much money we make each month, more easy its to invest and plan. Hence ability to take risk increases (Read the blog about Human capital, if you want to know more here)
- Your insurance coverage – Your insurance cover provides for those dark days in case something were to happen – so we can afford a bit of risk taking
- Time period of goals – Closer you are to our needs, the limited our ability to take risks.
- Dependents on you – More the number of dependents lesser the ability to take risks
Willingness to take risks – This is a mental make up from all of us as a kid. Our experiences, family all have a role in shaping this. Typically we all have seen some adventurous friends and some not so adventurous. This is the same with money as well, some have severe aversion to losses while some other get a nice feeling from making a risky gains.
Finally, it is important to be aware of our bias to risk. Then make use of the quantitative ability to take risk while making an investment decision.
