Guide to Risk Profiling
Before you consider investing in any ﬁnancial instrument, you must know how much risk you’re ready to take. Investing in the ﬁnancial market carries some inherent risk – which can be classiﬁed under systematic and unsystematic risk.
Systematic Risk comes from the inﬂuence of external factors on an organisation – those which are not under the control of the organisation. It includes risks such as interest rate risk, foreign exchange risk that are at a macro level which the organisation has no hold on.
Unsystematic Risk refers to the internal risks that an organisation is exposed to which are usually within the control of the organisation. These include business risk such as management decisions, ﬁnancial risk such as proﬁts and losses and operational risk which pertains to the manpower that a company employs. While these are the overall risks that concern the ﬁnancial markets, you must, at an individual level recognise yours before you start investing.
What is Risk Profiling?
A risk profile is an evaluation of an individual's willingness and ability to take risks.
Risk profile is broadly a factor of:
✓ Your risk capacity,
✓ Your risk tolerance and
✓ The risk you need to take to achieve your planned financial goals
Why is it important in Financial Planning?
A risk profile is important for determining a proper investment asset allocation for a portfolio. Every single person has a different risk profile as the risk appetite depends on psychological factors, loss bearing capacity, investor’s age, income & expenses and many such other things.
Your financial advisor can help you take a short and simple risk assessment to help you determine which category you fall under. Based on this, he/she can determine what proportion of your portfolio should be invested in which asset class.
Types of Risk Profiles
|Risk Profile||Investor Profile||Possible Asset Allocation*|
|Conservative||Investor's top priority is safety of capital and he/she is willing to accept minimal risks and hence, receive minimum or low returns.||Equity: 0-10%
Debt and others: 90-100%
|Moderately Conservative||Investor is willing to accept small level of risk in exchange for some potential returns over the medium to long term.||Equity: 10-30%
Debt and others: 70-90%
|Moderate||Investor can tolerate moderate level of risk in exchange for relatively higher potential returns over the medium to long term.||Equity: 40-60%
Debt and others: 40-60%
|Moderately Aggressive||Investor is keen to accept high risk in order to maximize potential returns over the medium to long term||Equity: 70-90%
Debt and others: 10-30%
|Aggressive||Investor is willing to accept significant risks to maximize potential returns over the long term and is aware that he/she may lose a significant part of capital.||Equity: 90-100%
Debt and others: 0-10%
Note:*This is a model portfolio for understanding the concept and not a recommendation (#Others means, fixed or low-risk investment)
Mutual funds help you invest across asset classes as per your risk appetite.
If you are investing in debt or equity through mutual funds, you can choose a mutual fund category depending on your risk appetite and time horizon.
Risk profile may change over time, depending on changes in your life cycle. Maybe your income changes or you have new goals, etc. Hence, what was right and worked for you at age 25 may not be the same when you turn 45.
Therefore, it’s important to assess your risk profile periodically since this may shift during your lifetime depending on changes in your life situation (when your financial obligations get fulfilled, you have new financial obligations, your income levels change, etc.)
Source: Internal, Equity Master
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