Risk Appetite

No books or periodicals offer you a theory on risk appetite and investment
GAURAV MASHRUWALA

Try searching the phrase “risk appetite’’ on Google or Yahoo among others. All the search result would most likely refer to risk appetite for non-individuals. A few websites would have made reference to risk appetite for individuals, but you would note that none has a formula to measure an individual’s risk appetite. Next, pick up books, journals on investments and search for chapters or sections on risk appetite. If you are an enthusiast who attends seminars on investing, ask the speaker to teach you science of measuring risk appetite. In fact, there is no formula to measure risk appetite for individual investor. ‘Advising investor based on their risk appetite’ is the biggest humbug coined by financial distributors to ‘sell’ higher commission products. If your financial distributor is handing over a risk appetite questionnaire, ask him who designed it. What experience does the individual or team has in understanding investor psychology? Which psychological theory has been relied upon to develop the questionnaire? Imagine a patient sitting in a surgeon’s cabin. Before proceeding with examination, surgeon hands over a questionnaire to patient. Initial questions are about patient’s name, address, contact details, age, gender etc. Next, there are questions about patient’s health history. Last part is most important. Here, the surgeon examines patient’s surgical appetite. In this section there are questions like (1) How do you react to anaesthesia (2) Will you get scared if you see your own blood (3) On scale of 1 to 5 rate your reaction to pain at day and pain at night (4) do your prefer to suffer from illness or do you prefer going through the pain of treatment etc. Surgeon then explains to relatives of patient how the questionnaire has been designed in consultations with ‘experts’ and how it helps in gauging surgical appetite of patient. Surgeon further states that he would perform surgery only if a patient has surgical appetite. Do you find the above scenario humbug? Yes, it is. No surgeon ever decides whether to perform surgery or not by asking questions to patients. Nowhere in the medical books there is any theory on surgical appetite. The surgeon performs the surgery based on patient’s symptoms, conditions and necessity for surgery. The point is there is no concept of either surgical appetite or risk appetite. No books, periodicals or any other form of literature on investments have theory on risk appetite. However, the word risk appetite is frequently used by so-called investment consultants. Questionnaires are given to potential investors. Investors fill those questionnaires and, based on the feedback, financial products are offered or sold to them. The replies stated in questionnaire have no collations to individual’s capabilities to withstand volatility. All of us react to risk and volatility of our investments differently at different point in time. One of my clients was aghast in 2001, when I told him 50% of his portfolio should be in equity. According him investing in equity is like speculating. Same client wanted to invest 100% of his funds in equity in Sept 2007. As a financial planner I did not see anything surprising in this behaviour. The way whether to perform surgery or not has to be decided by surgeon, similarly an investor should invest in equity or not has to decided by the advisor. If advisor feels that investor will have to invest in equity to reach his/her desired goals, he should recommend equity. Recommendations should be solely dependent on investor’s future financial goals. It has nothing to do with his or her risk appetite.

Times of India Mumbai, Page 25, 4th Feb 2008