Understanding risk profile with examples and types
The stock market is associated with risk. Volatility in the market makes investment risky. As risk is too much to bear for the investors, it is important to understand the risk profile to manage the risk efficiently.
Risk profile meaning
A risk profile is the ability of risk tolerance in an investor. Every investor has a different risk appetite depending on a variety of factors like disposable income, age, etc. Investment Risk profiling is creating a specific investment portfolio with mixed assets related to an investor’s risk profile. An example of a risk profile is an individual who would maintain the value of his portfolio rather than aim for high or moderate returns. On the contrary, an individual who is ready to take the market volatility to earn huge returns can be termed a risk seeker profile.
Risk profile assessment
Investors examine their assets and liabilities carefully to determine the level of risk that they can take. Financial advisors also use the asset-liability balance to determine the risk profile of an investor. For example, an individual with many assets and few liabilities at his disposal can be a risk seeker. Also, an individual with enough retirement capital, no loans, and sufficient emergency funds may also fall in this category. As the financial standing of the individual will not suffer during short term market volatilities, he can take risks to get huge returns. On the contrary, an individual with very few assets and significant liabilities will be risk-averse as they cannot handle loss from short term volatilities.
One thing to note here is that owning many assets with fewer liabilities doesn’t always make an individual a risky investor. It majorly depends on his psychology and risk-taking behaviour.
In addition to asset-liability balance, here are some other factors that affect the person’s risk profile and act as a risk analyser:
- Age – Young investors are more likely to take risks than individuals reaching the retirement age soon.
- Lifestyle – Individuals who are unmarried and are in the early stage of their career can take risks when compared to individuals with dependents.
- Financial goals – An individual prefers a risky approach when he wants to accumulate substantial capital for the future.
Types of risk profiles:
There are three types of risk profiles:
- Conservative – Conservative risk profile is a low-risk profile. Investors who fall in this category are the ones who prefer to keep their corpus safe. Investment options suitable for such investors are corporate bonds, treasury bills, sovereign bonds based mutual funds
- Moderate – Investors who strive to balance risk and returns fall in this category. These individuals go for high returns but only take a moderate level of risk. Their portfolio contains equities with debt instruments.
- Aggressive – Investors who are willing to take the risk of market volatilities in the expectation of gaining the high returns come in this category. They are well-versed with the stock market and have long-term planning. Investing in equities is ideal for them.
The risk profile for any individual should depend on how much they are investing and how much they expect the returns, in addition to the time for which they can maintain the investment.