What is Risk Appetite?

Back to School Week: Guest host Alex Gard asks Morningstar's Dan Kemp what risk appetite is and why it matters to investors

Holly Black 7 September, 2020 | 1:44PM
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Holly Black: It's back to school week at Morningstar and to help cover all the investment basics we have brought back our team of young experts. Luckily, they are as good at technology as they are at grilling our analysts.

Alex Gard: Hello. My name is Alex Gard. And today, I'll be talking to Dan Kemp about risk. Hi, Dan.

Dan Kemp: Hello, Alex.

Gard: What is risk appetite?

Kemp: So, risk appetite is a really important subject. All of the investments that we make involve some type of risk. So, if I were to lend you some money, there is a risk that you might not pay it back. And so, I have to work out whether I'm happy to take that risk and lend you that money. And so, risk appetite is the way that we describe the amount of risk people are willing to take.

Gard: Okay. Why does it matter?

Kemp: Well, risk appetite is really important because it helps investors find the right investments because although all investments have risk, they have different levels of risk. And so, it's really important that people have the right amount of risk in their investments primarily so that they can stay invested for the long term. So, one of the ways that we can think about this is that making an investment is a bit like getting on a rollercoaster. And some people like to get on the really big exciting rollercoasters and some people like the smaller, tamer, less exciting rollercoasters. But you need to make sure that you get on the right rollercoaster for you because otherwise you might get scared during the ride and want to get out at the wrong time. And so, matching the person to the right level of investment risk is really important.

Gard: Okay. Is it true that the more risk I take the better the returns?

Kemp: In general, that is true. But it's only true over the long term. And so, over the short term, what we find with the more risky investments is that the prices move around much more and that makes them more scary for people. And so, one of the great mistakes that we see investors make is they get scared at exactly the wrong time when they've lost a little bit money. And so, they've taken a risk, they've lost a little bit of money, and then they get rid of their investment and so they never see the benefits of those investments. And so, that's why matching the right level of risk to each person is really important. Otherwise, everyone just takes lots risks to try and get more gains but then find that they can't quite stay on that journey because they get too scared. So, rather than always taking the most amount of risk to get the highest amount of return, it's important to match the type of investment you have and the risk in that investment to the amount of risk that you are comfortable to take so that you don't have to worry about investments all the time. You can just let them move through time and hopefully pay you a good return in the long term.

Gard: Thank you for your time, Dan. For Morningstar, I'm Alex Gard.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Holly Black  is Senior Editor, Morningstar.co.uk