Despite the high return opportunities offered, investing is a world of risk. However, investment risks can be anticipated with risk management practices.
Investment risk management is a process that starts with recognizing risk and reviewing the risk profile. In addition, there are several concepts that investors need to understand as further mitigation measures: risk appetite, risk tolerance, and risk register.
Risk Appetite and Risk Tolerance
Wise investors apply the principles of risk appetite and tolerance in building their portfolios. That way, investment goals become more focused and it is possible to achieve optimal returns.
Risk appetite is the level of risk that investors are willing to take in order to achieve their investment targets or goals. Meanwhile, risk tolerance refers to the maximum risk limit that investors are still willing to take before facing greater risks.
The relationship between risk appetite and risk tolerance can be depicted as follows.
Risk Register
After recognizing risk, understanding your risk appetite and tolerance, and reviewing your risk profile, the next practical step in investment risk management is to create a risk register.
Risk register becomes a "map" for investors to make decisions when facing obstacles. With a qualified risk register, investment risks can be mitigated and the opportunity for returns to be obtained according to the target.
Risk registers in the investment realm can be used in depth to::
Note any investment risks that may occur.
Identify their impact on portfolio performance.
Determine mitigation efforts and what should investors do after.
Risk registers have many variations according to each individual's needs. However, a wise investor should at least create a risk register that includes:
Risk
Source / cause
Category
Probability
Impact
Mitigation strategy
Follow-up
Here's an example of creating a simple risk register.
Risk | Source / Cause | Category | Probability | Impact | Mitigation strategy | Follow-up |
Difficulty selling shares. | Pressure on industrial sector X resulted in an empty stock bid. | Liquidity risk | Low | Medium | Selection of issuers with high liquidity. | Regular monitor-ing. |
Stock price fluctua-tions. | Changes in govern-ment re-gulations and the attitude of company Y. | Regulatory risk | Medium | High | Portfolio diversifi-cation. | Regular monitor-ing. |
... etc. | | | | | | |
Investment Risk Dynamics and the Shifting Attitudes of Investors
You have learned the basic concepts of investment risk management by recognizing what risk is, reviewing your risk profile, understanding your risk appetite and tolerance, and creating a risk register. However, the journey of an investor certainly does not end there.
Investment risk is basically the possibility that returns will not be as expected, including the loss of some or all assets. Therefore, the definition of risk is subjectively related to one's investment target.
Investment targets will change over time depending on the investor's age, circumstances, also knowledge and experience. This in turn affects their risk profile, appetite, tolerance, and register.
Sample Case
Kevin started his investment journey after one year of employment. He targeted a return of 6-8 percent per year with the funds and knowledge he had at the time. With a low risk appetite, Kevin chose money market mutual funds and bonds instruments. He also took a high risk tolerance because he did not have any urgent financial responsibilities.
Now that he is financially stable, Kevin's risk appetite has become greater with a target return of more than 10 percent per year. He then chose stocks for medium and long-term investments. However, his risk tolerance is actually low because there are several financial dependents such as installments, household needs, and others.
As retirement age approached, Kevin reconsidered his investment plan. He lowered his appetite as well as his risk tolerance as a wiser move in retirement fund management. To achieve stable returns with medium risk, Kevin fills his portfolio with blue chip stocks and mixed mutual funds.
Disclaimer: The content is made for educational purposes, not a recommendation to buy or sell a particular stock. PT KAF Sekuritas Indonesia is licensed and supervised by the Financial Services Authority (OJK).
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