Usually one of the first steps a new investor takes is to self-diagnose their ‘risk appetite’.

Experienced investors are also often urged by money experts to keep their stance on risk under review as aging, surprise events and reaching life milestones will change priorities over time.

When it comes to investing, being willing to take more risk doesn’t (necessarily) make you a daredevil, or averse to risk make you a coward.

Either outlook, or taking a balanced view, can be a sensible approach to investing if it’s a good match with your age, attitudes and goals.

Risk appetite is not a character trait, it’s a matter of taking a considered investment risk in the right scenario. In fact, you might even need to consciously separate your personal inclinations from your decision-making to a certain extent.

For example, if you are naturally cautious with money and live on a carefully managed budget, but you are young and planning to make regular contributions to a stocks and shares Isa or pension for many decades to come, it makes sense to pick a high risk ready-made portfolio or set of funds.

Likewise, if you are an instinctive risk-taker but getting on in life, with family responsibilities and a retirement to think about funding, you might want to curb your impulse to take a big bet on one risky stock, sector or asset class, and force yourself to diversify into funds you find somewhat dull.

What is risk appetite?

It can obviously mean different things to different people, so we asked three money experts to explain it in the context of making investing decisions.

‘Risk appetite is your willingness to accept uncertainty in pursuit of potential returns. Your risk appetite level will guide your portfolio decisions and help balance risk versus reward in your journey’ – Sam North, market analyst at eToro

‘Risk appetite refers to the level of risk an investor is willing to accept in pursuit of their financial goals. It reflects a person’s tolerance for potential losses and their comfort with uncertainty in returns’ – Laith Khalaf, head of investment analysis at AJ Bell

‘Understanding and managing risk is one of the most important steps you can take to avoid common investing mistakes and stay on track to meet your financial goal.

‘When we talk about investment risk, many people immediately think of volatility – the unpredictable ups and downs of the market. But risk and volatility aren’t the same thing.

‘Volatility simply describes the natural fluctuations in market prices – both rises and falls – and it’s a normal, even healthy, part of investing. In fact, volatility is often the price investors pay for the long-term outperformance that investments can deliver.

‘Risk, on the other hand, is the chance that your investments might lose value over time, or that they don’t grow enough to meet your financial goals.

‘This is a more meaningful concept for investors to get to grips with, and crucially, it’s something you can control – at least in part’ – Tom Stevenson, Investment Director, Fidelity International

How do you work out your own tolerance to risk?

There is no blueprint but you should think about the interplay of these three issues when you choose investments to suit your own risk appetite.

1. What are your financial goals?

Here are some common financial targets and ways to approach risk as you pursue them.

House deposit, dream holiday, home renovation: Unless you don’t mind delayed gratification, plans like these probably have a nearer-term end date. If you need your money within a specific timeframe, it’s better to look to safer investments.

Your children’s future: It depends on their age of course but university costs, a car or a first property for your child are likely to be long term goals so you should consider taking more initial risk then reviewing this as they get older.

Financial Independence, Retire Early: These are usually medium to long term goals, but people attracted by the FIRE movement typically tend to pursue aggressive growth, although after a certain point some let compound growth do the heavy lifting in their fund.

Comfortable retirement: You can be adventurous in the early years because the benefits of regular investing, which force you to keep buying during marking upsets when stocks are cheaper, plus compound growth over time will see you through.

Some people intentionally derisk investments or have it done automatically for them by their pension scheme – a process known in financial jargon as lifestyling – in the run-up to retirement.

However, if you plan to live on your investments in old age you might want to stick with stocks for the greater growth potential.

Generate an income: Dividend paying stocks tend to be on the less risky side. Some people only take the ‘natural income’ – the actual dividends – from a fund and keep the rest invested. 

This is a strategy retirees sometimes use to avoid diminishing their funds too much during periods of market trouble.

Preserve capital: There are actively managed funds dedicated to doing this and they tend to invest in lower risk assets, and aim to smooth out returns even when markets are volatile.

2. How long are you going to invest for before you need your money?

The rule of thumb is to invest for at least five years if you want to give yourself the chance to generate decent returns.

For such a short period, you might want to be at the cautious or moderate end of the risk spectrum, say when choosing a ready-made off-the-shelf portfolio, or deciding how much exposure you want to emerging versus developed markets.

If you have decades to go before you need to sell your investments, you can invest more aggressively and still stay calm during market ups and downs.

3. Can you cope, financially and/or emotionally, with making losses?

Ask yourself how much money you could afford to lose, practically speaking, without it causing serious problems in the rest of your life.

If you have an emergency cash fund separate from your investments – which you certainly should – assess if it is sufficient to stop you needing to dip into investments during periods of market adversity, if your timing is unlucky.

Also, how do you feel about losing money, temperamentally?

Are you the kind of person who will wake up in the night gripped with despair during a global market sell-off, like say the current one caused by US president Donald Trump’s trade war.

Or will you shrug off setbacks and be prepared to ride out market shocks rather than be tempted to sell up.

Sam North of eToro says: ‘It’s important to remember that risk appetite is not static and it might change with the market volatility and personal circumstances.

‘It’s therefore important to reassess your strategies as market conditions evolve.’

Tom Stevenson of Fidelity says: ‘There’s no one-size-fits-all approach to risk. The key is to choose a level of risk that you feel comfortable with and that aligns with your goals.’

Are YOU an adventurous, balanced or cautious investor? Take our quiz below

Which investments are suitable for your risk appetite?

Broadly speaking, stocks are high risk but potentially high reward, while government and corporate bonds tend to be a safer and steadier option.

But also think about the risk spectrum within stocks. There are risky start-ups that might be future unicorns, well established and dependable dividend generators, emerging market funds and ones with exposure only to developed regions of the world.

It’s the same with fixed income bonds, as you can go for high-yield corporates or stick with sovereigns such as Germany, the US and the like.

‘Investors with a high risk appetite may be more inclined to invest in more volatile assets like stocks, aiming for higher returns despite the greater possibility of losses,’ says Laith Khalaf of AJ Bell. ‘Conversely, those with a lower risk appetite might prefer a blended portfolio which also includes safer investments such as bonds and cash.

‘For those looking for a ready-made blended portfolio, there are plenty of multi-asset funds out there which come in a spectrum of risk profiles to suit investors ranging from very cautious through to very adventurous,’

Tom Stevenson of Fidelity says: ‘The good news is you can manage risk not by trying to predict the market, but by building a diversified portfolio. This means spreading your investments across different asset classes (like bonds, shares and cash) and sectors to help smooth out performance over time.

‘It’s also worth bearing in mind that not all investment risks are as obvious as the gyrations of the stock market.

‘One that investors often underestimate is inflation, which can easily lead to an investor failing to achieve their financial goals. The best way to keep pace with rising prices is to invest in investments like shares, with greater long term growth potential.

‘That might involve taking what looks like a higher level of risk. The crucial thing is that this risk is calculated and sensible.’

He goes on: ‘Regular investing is another effective way to manage the ups and downs of the markets.

‘By investing consistently over time – even during market sell-offs – you ensure you’re putting money to work when prices may be lower, which can help smooth out performance and grow your portfolio over the long term.’

Take our quiz to assess YOUR risk appetite

There are no right or wrong answers here. Just work through the questions and mull over what your response tells you about the amount of risk you are willing to take with your investments, and whether it is the most suitable level for your current circumstances. 

Fidelity and eToro contributed to the following non scientific, but hopefully illuminating quiz.

When markets turned red in the Trump trade war turmoil, what was your reaction?

a) Suffered sleepless nights over your losses

b) Topped up while stocks are ‘cheap’

c) Purposely did not check your portfolio in case you’re tempted to sell

How would you react if your investment portfolio dropped by 10 per cent in a single month?

a) Sell everything immediately

b) Feel uneasy but hold

c) See it as a buying opportunity

How much of your income can you afford to lose?

a) 0-5 per cent

b) 5-15 per cent

c) Over 15 per cent

If a friend bragged about doubling their money in a risky trade, what would you do?

a) Warn them about the dangers

b) Be curious but stick to your plan

c) Jump in to try it yourself

If you held an investment which seemed safe but grew slowly, what would be your attitude?

a) Sell it asap

b) Review whether you should keep it

c) Consider it core to your portfolio

If you held an investment seeing dizzying growth, what action would you take?

a) Take profits, and rebalance your portfolio to ensure you aren’t over-exposed to it

b) Buy more

c) Be glad but keep it under regular review like everything else