A risk profile is an objective evaluation done by advisors to determine the predicted risks of a client’s investments. Such an evaluation is used to identify the amount of risk required for profitable returns, the amount of risk a client can afford to take, and the amount of risk the client can tolerate.
Risk profiling is crucial for adequately allocating assets in an investment portfolio. Every single investor has a different risk profile as the ability to take risks depends on various tangible and intangible factors such as loss bearing capacity, age, individual risk tolerance, the quantity and quality of assets, the amount and quality of liabilities, psychological factors, and many more such things.
By accurately predicting risks, organizations can avoid impending threats by taking measures in advance accordingly.
How is a risk profile evaluated?
There are a few ways to evaluate a risk profile.
Investors can assess their assets and liabilities to know where they stand in terms of risk. An individual with a lot of assets and lesser liabilities would likely have a higher appetite for risk. In contrast, a person with a lot of liabilities and not many assets would not be interested in risk-taking at all.
However, you should note that this is not always the case, and a person’s risk appetite is highly dependent on that individual’s psychology.
A risk profile can be evaluated by prioritizing risks based on the impact they could have on the organization and the probability that they could happen.
A risk profile can also be evaluated using a risk matrix known as a probability matrix or impact matrix to calculate the probability of potential risks.
What are the types of risk profiles?
There are three types of risk profiles. Each speaks to a certain level of the investor’s risk appetite. However, within each category, various factors could lead to the following groups of risk profiles:
-
Conservative
This profile means that an investor wants the least amount of volatility and is not willing to take any unnecessary risks. This is usually for investors with at least a two-year timeframe or those inclined towards interest-bearing assets, for the most part, with a tiny proportion of growth assets. This type of risk profile is for someone who is mainly concerned with the preservation of capital and is okay with low investment returns as long as the risks are also common.
-
Moderate
This is for individuals who aim to earn moderate to high gains and are not open to increased risks. These investors have a more balanced portfolio to maximize returns and minimize risks. They differ from the conservative category. They are investors with at least a three-year timeframe, emphasizing interest-bearing assets while having a higher proportion for growth assets. This also includes investors with a more balanced strategy with a timeline of up to 5 years. These people aim for modest capital stability and a higher risk appetite for increased returns.
-
Aggressive
An aggressive risk-taker always aims for the maximum gain possible. Such individuals have a longer time horizon and a higher risk appetite to go through various market fluctuations. These individuals have usually experienced investors who know how to play the game and trust their judgments. They don’t hold back from investing in enterprises that are just launching themselves right now but may yield a higher return later. They have a minimum of 9 to 10 years of the time frame and are willing to take risks more than any other investor. They tend to look for high potential investments, and capital stability is not considered.
How is a risk profile prepared?
A risk profile is prepared after assessing:
- The quality of threats that an organisation faces in pursuit of its objectives
- How those threats could impact the organisation negatively
- The probability of those threats affecting the organisation
- The chaos that could be created in the organisation by those threats
- The financial-bearing associated with each risk
- The organisation takes initiatives in the face of adversity to minimize or even avoid those threats to the fullest extent
Conclusion
Risk profiling is a critical step and should not be ignored when individuals want to invest in the stock market.
The stock market has a specific inherent risk categorized into systematic and unsystematic risks.
Systematic risks arise from factors external to an organisation and out of its control. In contrast, unsystematic risks are the ones that occur due to internal factors within an organisation and under its control.
Making a risk profile analysis and a risk profile matrix using a risk profile calculator is the safest way to prepare against any impending risks.
Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
Watch/hear on YouTube:
Start investing through a platform that brings goal planning and investing to your fingertips. Visit Kuvera.in to discover Direct Plans and Fixed Deposits and start investing today.
#MutualFundSahiHai #KuveraSabseSahiHai!
