Assessing your Financial Risk Profile

Risk in financial context refers to the uncertainty of returns your investments would fetch. Risk and return are directly proportional to each other i.e. the risk associated increases with increase in returns and vice versa. The risk associated varies from product to product. Low risk indicates lower but stable returns (E.g. Bank Deposits, Bonds, Debt Mutual Funds, etc.) whereas high risk indicates higher but unstable / volatile returns (E.g. Equity shares, Equity Mutual Funds, etc.).

 You may be familiar with people making following statements: “Stock Market is down and the valuation of my stocks has come down significantly, I need to switch my investments to Bonds!” “Investment in Bonds give me very low returns, I need to switch my investments to Stocks!”

 The sole purpose of financial risk profile assessment is to determine your risk profile category so that you may choose the investments that are best suitable to you and that are aligned with your financial risk profile.

If you are risk averse investor, you may feel uncomfortable if the stock market goes downward and you are holding a significant portion of your investment portfolio in equity investments. Conversely, if you can withstand short term volatility in Stock Markets, you may earn higher returns in the long term by investing in equity investments.

 Hence it is very essential to understand your financial risk profile before making any investment decisions.
Financial risk profile assessment is done with the help of a psychometric questionnaire which determines your Risk Capacity and Risk Tolerance. Some of the questions help determine your risk taking capacity which is your ability to take risk while other questions help determine your risk tolerance which is your aptitude to take risk. The overall financial risk profile is the outcome of your risk capacity and risk tolerance scores.

 Risk profiles in simple terms may be classified as Conservative, Moderate and Aggressive. Depending upon the risk profile, suitable Asset Allocation needs to be formulated. Asset allocation simply means how much you should invest into Equity investment products (Stocks/Shares, Equity Funds, etc.) and how much you should invest in Debt investment products (Bonds, Bank Deposits, Debt Mutual Funds, etc.).

For conservative risk profile, higher allocation to Debt investment products and lower allocation to Equity products may be recommended and conversely for aggressive risk profile, lower allocation to Debt products and higher allocation to Equity products may be recommended.

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