Question

Risk tolerance comes from risk capacity and risk attitude. What are the major determinants of risk capacity and risk attitude?

Answer 1

Risk capacity is the ability of the person to take risk.

The determinants of risk capacity are :

• The financial health of the investor.: If the investor is in a sound financial position, he is more capable of taking risks.
• The number of dependants : When the investor has fewer number of dependants , his risk taking appetite rises, in contrast to when he has a large number of dependants.
• Time horizon : When an investor has a long term horizon then he has a higher appetite for taking risks. When the investor is retired or his nearing retirement, his risk taking appetite falls.
• Goals of the investor: If the investor has certain goals which he needs to achive, then teh capaicty to take risks is reduced considerably.
• Responsibilities and expenses: When the expenses of the investor is high and he has a lot of responsibilities then the risk taking capacity falls.

Risk attitude is a state of mind. A person can be risk loving , where he loves to takes risk and risk averse where he does not like taking risks. This is dependent on the investors individual attitude.