The very term “risk appetite” seems like a simple enough and easy concept for most people to grasp. However, if one ponders on this much-used term for a couple of minutes, most of us would draw a blank. After all, what is one’s risk appetite, it has no definition and certainly no mathematical formulae, which will help one arrive at the number. Risk, as defined in the Oxford dictionary means, a situation involving exposure to danger or the possibility that something unpleasant will happen or a person or thing causing a risk or regarded in relation to risk. Now when one looks at the word appetite, which literally means hunger, and puts the two together, it either shows a slightly reckless side of human nature or a constant need for us to experience the rush of taking risks.
In the financial world, risk has a curious relationship with rewards. One usually believes that greater the risk greater the reward. Actually this statement is rather untrue. Risk is no doubt directly related to rewards. However, if one takes into consideration the goal, destination or “reward” in the financial world, one may notice that there are many ways to get there. Some maybe more risky and some less risky, however the reward will not be any different. Say for example, if you are leading a group of soldiers across enemy lines on mission. You may spot many different routes to get there, some more risky and some less. In this case, just because you have taken a riskier route does not make the rewards any greater. It is in fact a foolish decision to make. Similarly, with risk and rewards, one must realise that for gaining a certain reward, taking a certain minimum risk is necessity and usually greater the reward one is after, greater the risk one has to take, and it is not the converse.