Before writing the cheque for investment, it’s vital to know your risk appetite. This helps in identifying an appropriate mix of investments that are consistent with your risk appetite. In nutshell, it is important to be aware of and to recognise your risk-bearing capacity. This is called risk profiling.
So, let’s first try to understand what is the risk? Financial market experts define risk as a mathematical number for, e.g., volatility, etc., most of the common investors think of risk as the possibility of losing their investments (fully or in parts) or making less than expected returns.
Then what is risk profiling: Investors make investments to achieve certain financial goals. A risk profile comes prior to investing. Investors need to understand how much risk they can bear.
Typically, risk profiling involves assessment on four counts, as under:
Risk Capacity: Here, your financial risk-bearing capacity will be assessed. The level of financial risk you could afford to expose yourself and can manage comfortably based on your life situation, e.g., if you are a young salaried investor, then your risk capacity will be higher in comparison to a middle-aged man who has two children. Also risk capacity for a retired pensi0oner with limited means will be extremely limited.
Attitude to Risk: Here as an investor, your comprehension of risk and how you apply the same to your financial life will be assessed.
Risk Tolerance: This assesses your ability to cope with the volatility of capital markets psychologically and financially. This also factors in cash outflow in terms of financial liabilities that is needed in the next few years, like child’s higher education, payment for a house, daughters marriage etc.
Risk Requirement: This assesses your financial goals to understand what the degree of risk required to achieve those financial goals. This answers very fundamental questions like, if risk is needed at all in a financial plan or of the plan will be incomplete without a high degree of risk.
How a Risk Profiling is carried out: A sound financial plan balances your goals and your capacity to take investment risks ie., risk tolerance.
We at Mutualfundwala will advise investors on the following:
Risk profiling in mutual funds is extremely useful for all investors, but even more so for new investors. It helps you in setting right expectations out of your investments. It also allows advisors to get a comprehensive outlook of their client’s aspirations, attitude and tolerance level concerning investments.