When you make an investment, you expect:
- A return on the amount invested via interest, dividend, capital gain, etc.
- Return of the actual amount or capital that you have invested
When an investment assures you a return on the capital as well as return of the capital, it is called a safe investment.
The chance of either or both getting affected is called as risk. This chance or risk can be appear in a range of possibilities.
A risk profile is a indicator of what range of possibilities that you want your portfolio to be in.
Your risk profile helps you to pick a suitable portfolio allocation (more on allocations later).
What is your risk profile?
You have a mind, a hunch and then there are tools.
So, far you may have relied on the first two to make a guess about your risk profile. It is time that you use a tool.
Risk profiling tools come in various shapes and forms from a simple 3 questions one to a multi page assessment.
We will keep it simple.
Use this questionnaire to determine your risk profile. A set of 10 questions.
Complete this before you move ahead.
What’s your risk profile?
Let’s understand your risk profile
There are 3 dominant risk profiles. Based on the result you got, here’s what it means for you.
#1 Conservative
You are a conservative investor with low risk taking capacity. You do not wish to take any investment risk. Your priority is to safeguard your capital or preserve the value of your money. You are prepared to forego higher returns for peace of mind. You are willing to allocate not more than half of your portfolio to market linked investments, preferably lower.
#2 Moderate
You are a moderate investor with a medium risk taking capacity. You have an understanding of how market linked investments work. You prefer a balance between growth and safety. You can take short term market risk or loss of capital in order to increase the long term purchasing power of money. You are willing to allocate at least half of your portfolio to market linked investments.
#3 Aggressive
You are an aggressive investor with a high risk taking capacity. You have a large focus on multifold growth of your capital. Behaviourally and financially, you are ready to accept larger fluctuations in the value of your portfolio in exchange for potentially higher returns. You are willing to allocate the maximum allocation of your portfolio to market linked investments.
Warning: It is quite likely that you may have got a moderate risk profile but deep down you wish to be aggressive in an approach. My suggestion – don’t.
I have seen too many investors living that dual life and causing great stress to themselves. You don’t want to be one more.
Stick to your risk profile.
You may periodically (once a year) evaluate your profile again and make portfolio changes, but what the questionnaire tells you is largely true of your appetite for risk .
IGNORE THIS AT YOUR OWN RISK. 🙂
Once the risk profile is established, it is time to go to step 2 and determine an asset allocation that suits your profile.