Just like every person’s spice tolerance when it comes to food is different, every investor’s ability and desire to bear investment risks is also different. Some people can slurp the spiciest ramen noodles happily, others can barely tolerate black pepper and similarly, some investors can take high levels of risks while others merely want to protect their capital. It’s essential to understand what your risk tolerance or risk profile is before you begin investing. This will help you undertake strategic asset allocation between equity and debt investments. It will also help you build a portfolio that could meet your financial goals in the most efficient way.
Before moving to risk profiling, however, it’s essential to understand the two primary types of risks that impact your investments – systematic risks and unsystematic risks. Systematic risk refers to the broader market risks or the risks external to the company. These include macro-level risks such as interest rate risk, recession, foreign exchange risk, etc. This is usually what is referred to as market volatility. Unsystematic risks, on the other hand, are risks specific to a company or industry and are internal. Examples of unsystematic risk include management decisions, company’s utilisation of resources, product recalls, etc. Now that you know this, we can move on to risk profiling.
What is a risk profile?
Every investor has a specific risk profile. This is essentially your willingness and your ability to take risks when investing. It is dependent on a few crucial factors such as your age, income, personality, and financial obligations. Depending on these factors, the following are some of the most common risk profiles.
Risk profiling and portfolio management
- Conservative
Here capital protection is the utmost priority. Hence, at the cost of low returns, minimal risks are taken. Here, equity allocation would tend to be 10% or less while the remaining would be debt.
- Moderately conservative
While the safety of capital is still the priority, some risk is taken to earn returns. Equity allocation would be around 10% to 30% while the remaining would be invested in debt and other instruments.
- Moderate
A moderate level of risk to earn higher returns is taken over a medium to long-term investment horizon. Here, the allocation between equity and debt investments would usually be equal.
- Moderately aggressive
Here the priority is to maximise investment returns and hence a high level of risk needs to be taken. The asset allocation is heavily equity-oriented, around 70% to 90%.
- Aggressive
With the goal to maximise returns, a significant level of risk is taken with investments that are usually long-term. Hence, equity allocation here would be 90% to 100% with minimal to no debt instruments.
Figuring out your risk profile
Figuring out your risk profile accurately by yourself can prove to be tricky. Hence, you can consider seeking the help of an investment advisor or a money manager. A financial advisor can help you to look after other essential aspects of portfolio management and to understand your risk profile.
