Page 38 - Banking Finance July 2024

ARTICLE

Risk tolerance is the level of risk that an investor is willing
to accept in their investment portfolio. It is based on an
individual's financial goals, investment time horizon, and
willingness to tolerate fluctuations in the value of their
investments. Investors with a high-risk tolerance may be
more comfortable with volatile investments, such as stocks,
while those with a low-risk tolerance may prefer more stable
investments, such as bonds.

Asset allocation and risk tolerance are closely related
because the mix of asset classes in your portfolio should align
with your risk tolerance. If you have a high-risk tolerance,
you may allocate more of your portfolio to stocks, which
have the potential for higher returns but also come with
higher risk. On the other hand, if you have a low-risk
portfolio across multiple asset classes, you can reduce risk tolerance, you may allocate more of your portfolio to bonds,
and increase your chances of achieving your long-term which are less volatile but offer lower returns.
investment goals.
It's important to note that risk tolerance can change over
Asset Allocation and Risk Tolerance time, so it's important to periodically review your portfolio
Asset allocation refers to the process of dividing your and adjust ensure it continues to align with your goals and
investment portfolio among different asset classes, such as risk tolerance.
stocks, bonds, real estate, and commodities, to achieve a
balance between risk and return. Asset allocation is based Conclusion

on the principle that different asset classes perform The purpose of investing is to give your money the
differently under different market conditions, so investing opportunity to grow and help you work towards your other
in a mix of asset classes can help reduce risk and increase life goals. The earlier you start, the more time you can give
returns over the long term. Broadly speaking, there are two your investments to reach their potential. In conclusion,
basic types of investment - stocks and bonds. While stocks understanding asset classes is a fundamental aspect of
are high-risk with high returns, bonds are usually more successful investing. Asset classes provide a framework for
stable with lower returns. To minimise one's risk exposure, organizing investments based on their characteristics, risk,
one should divide one's money between these two options. and return profiles. Ultimately, a sound understanding of
The trick lies in balancing the two, in finding equilibrium asset classes and their role in portfolio construction is critical
between risk and surety. for investors seeking to build and maintain a successful
investment strategy.
Asset distribution is typically based on age and lifestyle. At
a younger age, one can take a risk on one's portfolio, opting When planning your investments, you should be aware of
for stocks that offer high returns. the prejudices and ideas that are likely to influence your
decisions. We are often influenced by external factors,
A good way of allocation is to subtract your age from 100 - particularly risk aptitude, family attitude, luck, and cultural
this should be the percentage of stocks in your portfolio. For beliefs. The risk aptitude refers to the level of risk you will
example, a 30-year-old could keep 70% in stocks with 30% be willing to take, which often depends on the family
in bonds. On the other hand, a 60-year-old should reduce background and cultural attitudes. Young adults from well-
risk exposure, hence, the stock to bond allocation should be off families are more likely to go for high-risk, high-return
40:60. However, you may have to factor in your family investments. On the other hand, those from a modest
finances when taking these decisions. background are more likely to invest in safe portfolios.

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