There are rewards for investors who are averse to taking market risk

They don't have to put their money in equity trade and yet build a corpus for their financial goals

Some investors won’t bat an eyelid if their portfolio crashes 25-30 per cent and others worry even if it is down just half a per cent: Tolerance for risk is shaped by experience, personality and money at stake.

What should investors with low appetite for risk do? Should they take exposure to stocks or equity funds?

Before we get there, I want to contrast between risk-taking ability and risk tolerance/appetite.

Risk-taking ability depends on age, net worth, cash flows, financial goals, family situation and other factors.

Let’s say A and B need Rs 1 crore for retirement. When they do, A has a net worth of Rs 1 crore and B of Rs 10 crore. B’s risk-taking ability is clearly higher than A. Even if B loses some money, she still has money to retire comfortably. A does not have that luxury.

Risk tolerance is about how you react/behave when the markets move adversely. Investors with low tolerance need not be risk averse in general. It is not that they are unable to make risky investments, but just that they struggle to cope with volatility in equity prices.

Real estate prices are volatile but investors do not check the market value of a property change every minute and are fine holding real estate for the long term. There is a conviction that real estate prices always go up (which may not be correct). Whatever the reason, it helps you hold on to your real estate for long term and ignore volatility.

Because of my profession, I interact with many entrepreneurs and professionals (non-salaried). They are game with the risk in their work, but not all of them are comfortable about volatility in investments. Here is what investors with low-risk tolerance

Approach 1

If you cannot digest market volatility, you don’t have to invest in equity markets. While you may forgo greater return potential, avoiding equities is better than buying high and selling at market lows.

It is not that you cannot achieve your goals if you don’t invest in stocks. Let’s say you want to accumulate Rs 1 crore for retirement in 20 years. You invest in a multi-asset portfolio (let’s say just equity and debt) and expect to earn 10 per cent post-tax on your investments. You need to invest about Rs 14,000 per month and you live with volatility.

Short-term volatility is a lesser problem to a patient investor who is in the accumulation phase. For such an investor, the losses are only notional. On the other hand, to an investor who is withdrawing from the portfolio (decumulation mode), market volatility translates to real risk of missing out on their financial goals.

Investors may shun all volatility and simply put their money in Employees Provident Fund (EPF), Public Provident Fund (PPF) and bank fixed deposits. They will earn 7 per cent interest per annum on their investments. They will have to invest about Rs 20,000 per month to reach their target in 20 years.

Approach 2

Investors put that portion of your assets in the equity market that won’t worry them. It could be 10 per cent or 20 per cent or whatever you are comfortable with.

The right percentage is one that you wouldn’t worry about checking the value of equity investments for a couple of years. You can rebalance your portfolio at regular intervals to keep equity allocation within your comfort zone.

Approach 3

You divide your investments into buckets. Let’s say the money that you need over the next 5-10 years goes to fixed deposits. Anything longer, you consider some exposure to equities. You won’t be as much worried about market movements if you know that you won’t need to touch these investments over the next 10 years. This approach can be useful in retirement.

Some retail investors risk tolerance goes up when the markets are doing well. Greed sets in. These investors never looked beyond bank fixed deposits / PPF / EPF in their lives. Suddenly, they think they can’t go wrong with stocks. When they lose money, fear replaces greed and they exit taking huge losses.

If you are new to equity investments, do not dive headlong but start with a small allocation. As you learn more about your true risk tolerance, you can tweak your allocation.

The best portfolio for you is the one that lets you sleep peacefully at night.

The author is a Sebi-registered investment advisor.