How to find your real risk appetite? Experts explain how to identify it and build the right portfolio

Many investors believe they have a high risk appetite when markets are rallying. But the real test comes during sharp market corrections, when panic often leads to premature selling.

Experts say investors should assess both their financial capacity and emotional ability to withstand market volatility before deciding how much risk to take. Understanding your true risk profile can help you avoid costly mistakes during market volatility.

So, let's understand the clear process of finding risk appetite and how to create a portfolio accordingly.

A step-by-step framework to identify your risk appetite

Step 1: Assess your financial ability to take risk

Begin by evaluating your financial position, including income stability, emergency savings, insurance cover, liabilities, existing wealth and dependence on investment income. These determine how much risk you can realistically afford.

As Aditya Agarwal, Co-Founder, Wealthy.in, says, “Someone with a secure income, adequate contingency reserves and a long investment horizon can generally afford to take more investment risk.”

Echoing this, Thomas Stephen, Director & Head - Preferred, Anand Rathi Share and Stock Brokers, says, “If one is relatively confident of continued income in the future or has a sufficient portfolio already created, then he or she may be willing to invest in more risky assets.”

He also adds that “the availability of a good emergency corpus or adequate insurance cover provides comfort to the investor to invest in asset classes accordingly.”

Karan Aggarwal, Co-Founder & CIO, Ametra PMS, notes that “Lower savings rate (<30%) and high monthly EMI/income ratio (> 30%) reduce risk-taking capability of investors.”

Step 2: Align risk with your age and investment horizon

Your age and the time left to achieve your financial goals are among the biggest determinants of risk appetite.

Stephen says, "An elderly person or someone who is approaching retirement maybe more keen on capital preservation whilst a young individual may be willing to take more risks." He further explains, “Usually as the financial goal draws nearer, the investor tends to veer more towards capital preservation.”

Aditya Agarwal says, “Money required within three years should typically be invested conservatively, whereas investments meant for goals that are 10-15 years away can generally withstand greater exposure to growth assets like equities.”

Step 3: Understand your emotional tolerance for market volatility

Risk appetite is not just about finances but also about your ability to stay invested during market declines.

Aditya Agarwal advises investors to “Ask yourself how you would react if your portfolio declined by 10%, 20% or even 35% during a market correction.”

Karan Aggarwal says, “Retail investors are driven primarily by return considerations and end up exiting investments at losses in the case of negative risk events.”

Understanding your emotional response can help you avoid taking more risk than you can comfortably handle.

Step 4: Factor in your investment experience and goals

Your investment objectives and market knowledge should shape your risk profile. Aditya Agarwal says, “Different goals warrant different levels of risk.”

Stephen adds, “An experienced investor who has witnessed different market cycles and the respective ups and downs would be better placed to understand the relative risk involved when starting a fresh investment. Similarly, having higher knowledge of the markets also aids in better understanding of possible risks associated with any investment.”

Matching your experience with your financial goals can help you build a risk profile that you can maintain consistently.

What should your portfolio look like?

While there is no one-size-fits-all allocation, experts suggest the following broad framework.

Stephen highlighted that “there is no fixed rule on how one should allocate their investments even if they have determined their respective risk profile.”

Aditya Agarwal concluded that, “the objective is not to maximise returns at all costs, but to build a portfolio that investors can remain invested in through both bull and bear markets.”