Human psychology:
Everyone has their own experience with risk handling. For someone, a 10% drawdown of capital could be a big number, and for someone, a 25% drawdown could be a small number to catch their attention. So, it differs from human to human depending on their experience with risk management. While choosing any investment product, one should ask their investment advisor: What is the maximum drawdown possible in any investment product? and try to imagine that they can control their emotions to that extent. If yes, then only they should go for that product, but make sure that once you opt for that product, you will not change your decision to switch to another product until that loss limit is breached. In other words, if an investment advisor suggests that this product can have a 30% drawdown, make sure you can control your psychology and will not exit at 20%.
Time Duration:
This factor plays another important role in risk appetite. If you are investing for a short duration, which may be less than 1 year, you should not opt for risky products; rather, you should go for capital-protected products only. For long-term investment, one should look at the probability of a fund withdrawing before its maturity. If someone has not maintained a contingency fund, there is a high probability that they may have to withdraw a partial or full invested amount before its maturity. So, one should either maintain a contingency fund or not put 100% of their capital into long-term products.
Fund ownership:
If you have borrowed funds, which you may have to return in the future, or you are investing in a leveraged product; in other words, if 100% of the money invested in the market is not yours and you are taking funding from a broker, NBFC, or bank, you should take the least risk with such an investment. Because suppose you have taken 75% of the funding and 25% is your own capital. In that case, if that investment loses 20% of its investment amount, you will lose 80% of your money. So, one should have a minimum risk appetite for leveraged products.
Conclusion:
Psychology and time play important roles in investment. You should only invest those funds in the stock market that are available for the long term and avoid investing in leveraged products or investing after wise calculations.
(The author, Ravi Singhal, is the CEO of GCL Broking.)
