Evaluating Your Risk Profile

We are glad to have you with us for our 3rd Session on Retirement Planning - Evaluating Your Risk Profile

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In the world of investments, investors often make the mistake of misjudging their risk appetite. Many investors easily fall for financial instruments which may not be suitable for them or at times even invest in unregulated instruments. This is quite common in cases where investors get carried away by some extra ordinary gains made by their friends or relatives or on the basis of misleading advice.

In such cases, it may happen that the returns on offer would look really attractive; but they may come with a level of risk you cannot afford to take. After all, it is your hard earned money and you should invest it prudently.

So, in this session of money simplified we will help you understand why is it critical to consider risk when we talk about investing and how you can evaluate your risk profile.

Why is it critical to consider risk?

  1. Any discussion about investing is incomplete unless it underlines the risk along with the potential return.

  2. Very often we all want to earn high returns on our investments. But high returns come at a price. Remember, there are no 'free lunches'!

  3. As earning high returns also calls for taking high risk, not all are comfortable taking high risk. Thus before you consider any investment product which claims to offer you high returns, it is critical to assess the risk associated with such in1vestment products in conjunction with your own risk taking ability.

  4. Although you may understand what we mean by 'Risk', you must also know that there is a difference between your 'Risk Appetite' and your 'Risk Tolerance level'.

Risk Appetite vs. Risk Tolerance

While 'risk appetite' refers to willingness of an individual to take risk, 'risk tolerance' implies the ability of an individual to tolerate the level of downside risk.

Determinants of Risk
Risk Appetite Risk Tolerance
1. Your current age
At a younger age you have the advantage of time and may have willingness to take high risk.
1. Your current financial situation
You can assess your current financial situation by considering factors like your income, expenses, assets, liabilities and financial responsibilities that you are shouldering. A favourable current financial situation may help increase your risk tolerance level.
2. Your past experiences with your investments
Going by your past experience, if you have earned substantially higher returns in the past, you may have the heart to take more risk.
2. Your contingency funds
Your savings for a rainy day can enable you to take risk. If you have failed to maintain adequate funds for your contingency needs, your risk tolerance level could be low, as you are not financially ready to manage any contingent events.
3. Your Knowledge
A thorough knowledge about something increases your awareness. Becoming aware about good and bad effects completely, may help you analyse risk better.
3. Nearness to your financial goals
The time left to achieve your goals also determines the risk that you can prudently afford to take while investing. If your financial goals are far away, you can afford to have a higher risk tolerance level. But if your financial goal is near, then your risk tolerance level is usually low.
  4. Insurance Coverage
Life being uncertain, you would not want to pass on any financial burden to your loved ones. If you do not have an optimal life insurance cover, your risk tolerance level would be low.

Risk Profile

Risk Profile = Risk Appetite + Risk Tolerance

As you can make out from this equation; your risk profile is a combination of your risk appetite and risk tolerance level which helps in prudent risk assessment.

Once you have identified your risk appetite and risk tolerance levels well, you would be nearly close to assessing your risk profile.

So, it is a combination of your risk appetite and your risk tolerance that you need to consider before you take any major investment decision.

Categories of Risk Profile

Based on your risk profile, you as an investor can be broadly classified as...

  • Risk Seeker or Aggressive: If your risk profile is high, you are an aggressive investor and may be willing to take high risk.

  • Risk Neutral or Moderate: If your risk profile is between medium to high, you would be moderate on your risk. You may be looking to earn decent return at a relatively lower risk.

  • Risk Averse or Conservative: If your risk profile is between low to medium you are a conservative investor and risk averse in nature. You may not be comfortable in taking risk.

Risk profiles can be further fine-tuned to include five instead of three categories, viz., Aggressive, Moderately Aggressive, Moderate, Moderately Conservative and Conservative.

Indicative Portfolio Allocations
(Based on Your Risk Profile)

Risk Profile Equity Debt Gold
Aggressive 65-85% 5-20% 10-15%
Moderate 40-60% 35-50% 5-10%
Conservative 10-25% 70-80% 5-10%
(Source: PersonalFN)

Equity / Gold must have a minimum horizon of 5 years and their higher values may be chosen for very long term goals. One must follow a glide path or de-risk his portfolio to debt as goal nears.

The aforesaid portfolios are for illustration purposes only and should not be construed as investment strategies / investment advice. Investors should consult their investment advisor and construct their portfolios based on their risk appetite, time horizon, investment goals, etc.

Here is an Indicative Portfolio Allocation, for investors having different kinds of risk profile.

For an investor with an aggressive risk appetite, allocation to equities would be relatively higher for goals which are very long term in nature.

For a moderate risk appetite, allocation to equities will be slightly lower than that of an aggressive investor. Such investors should balance their portfolio between equities offering growth and debt to cushion the downside risk.

If you are a conservative investor and are risk averse, seeing a loss in your portfolio is most likely going to make you uncomfortable. So, you need to prioritize the protection of your capital. Depending on your age and investment time horizon, a major portion of your investments would be in debt.

Points to Remember

  • While there is information galore on investment avenues, you ought to adopt caution.

  • Ensure that you are taking a wise investment decision which suits your needs and risk profile.

  • There is no point in being carried away by an investment opportunity which has been hyped even though it may be really worth it. And do not indulge in in something that does not suit your risk profile or you do not understand.

  • You should be cautious of investment opportunities which harp on returns and do not emphasise on the risk involved.

  • As a matter of fact in the absence of information related to risk, information isn't just incomplete, it may be downright misleading!

    So to end our learning exercise today, we now invite you to test your learning by taking up this simple quiz (and win exciting prizes!)

    Just Click On The Link Below.

Thank You For Participating!

The Information contained in this video transcript is not a complete representation of every material fact and is for information purposes. All details are provided on a best effort basis. It is not to be used or considered to be an offer to sell or buy units of Franklin Templeton Mutual Fund schemes. This video transcript is for information purposes only, provided on an ‘as is’ basis. Nothing in it should be construed as personal financial advice. You are responsible for your own investment decisions and the recipient is advised to consult a professional financial advisor prior to arriving at any investment decision. The video transcript is for personal non-commercial use only and may not be copied, stored, redistributed or broadcast in any way. We recommend you read the complete Terms of Use of the website.

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