Risk assessment is vital to build an optimal investment portfolio

moneycontrol.com:

Every investment has return expectations. While large negative deviations in the short-to-medium term are common in stock market investments, they often revert to the mean return expectations over the investment horizon. The uncertainty of returns and the deviations is referred to as risk.

However, if an investor’s risk appetite is too low to tolerate short-term losses, ETF holdings would be sold prematurely at the occurrence of a negative event and losses would be booked, leaving a big hole in wealth.

Adding sanity

Traditionally, retail investors are driven primarily by return considerations. In their search for returns, they often end up with a portfolio that is riskier than their actual (but unknown) risk appetite and they end up exiting the investments at losses in the case of negative risk events.

Whether it was the small-cap funds in Q4 of 2021 or crypto at the beginning of 2022, most terrible investment decisions by a majority of investors are driven by risk appetite ignorance and the obsession with high returns. In general, investors end up playing blind in the hope that high returns of the past would continue in the future without any consideration of risk appetite for negative risk events. Risk appetite ignorance ensures that a normal negative risk event becomes a risk shock for investors.

Risk assessment is a simple yet clever hack that addresses the risk appetite ignorance woes of investors and adds a degree of professional finesse to portfolio construction. Risk assessment provides investors with knowledge about their risk-taking capability and helps them decide whether an investment is suitable for their portfolio. It ensures a low probability of risk shocks and allows portfolios to stay on course towards