Risk appetite vs. allocation: many ‘risk’ personalities in you

Your spouse may be afraid of socializing due to fear of contracting COVID-19. But, you can be adventurous, arguing that wearing masks and building herd immunity is a better way to combat the virus. Does your risk attitude towards sociality reflect your behavior towards personal finance decisions?

Here, we show that you have a number of at-risk approaches and how this affects your personal finance decisions.

Stable symptoms?

Despite the risk of contracting COVID-19, you can socialize with your friends, but you may be at risk when making investment decisions. Your husband may try to take risks while making investment decisions, but cannot participate in adventure sports like bungee jumping. Why?

Risk is the possibility of adverse consequences in the future. Your risk attitude is a function of perceived benefits and associated risks. Therefore, if you prefer risky investing, but do not do adventure sports, it may be that you experience less risk in the market and greater returns of high returns, while giving you a higher probability of adverse outcome from bungee jumping. Huh. So, you can be a risk taker while taking some decisions and risk for others. This means that your risk behavior is not a static personality trait.

We can extend this argument further. Does your risk behavior change for each investment decision you make? That is, is it possible that you prefer conservative investment for one life goal, but choose risky investment for another?

Suppose you are pursuing two life goals – saving for your child’s college education in 10 years, and planning a payment for the house you want to buy in 8 years. Clearly, your child’s education fund is more important than home. Why? On a philosophical note, you are responsible for accumulating funds for your child’s education. From a personal finance point of view, the answer is simple – you cannot postpone this goal. Therefore, it takes priority.

Setting priorities for life goals is important because you have to use your income to fund your current lifestyle and also save for the future.

Therefore, investing only in fixed income products such as bank deposits will not be possible for all life goals as the required amount will be large. You will also have to invest in equity.

But you will not be willing to take a high risk for a higher priority goal such as your child’s education, while you can accept a higher risk for the portfolio to fund a down payment for the home. This indicates that there are many at-risk personalities associated with your investment decisions.

Your asset allocation is a function of your risk attitude. So, conservative risk behavior towards your child’s education goal means that you should have more bonds and less equity in the portfolio set for this goal.

Whereas, your housing target may have more equity and fewer bonds because you have a higher risk tolerance for this target. Note that your asset allocation is driven by your goal priority and not necessarily the goal you want to achieve first. For example, the investments you make for 15 years, the high-priority round-trip, have more bonds and less equity than the 10-year, low-priority target.

Your risk attitude towards life goals may be different from your spouse. You may consider buying a house important while your spouse needs a foreign holiday on priority. You must bridge these differences before making investment decisions.

Remind your investment advisor that you have multiple risk personalities so that asset allocation is tied to your risk outlook for each goal.

(The author provides training programs for individuals to manage their personal investments)