Know the Importance of Risk Profiling and Understand the Risk Profiling Process

Before investing in the market, one factor which usually worries every investor is Risk. People worry about losing their investment capital or getting less than the expected returns, however, in technical terms, risk is usually a mathematical number like volatility which can directly affect your investment capital.

Every other investor will have different tolerance to market volatility. This difference is created due to various variable factors including income, liabilities, age, etc. In common terms, the quantification of risk bearing capacity of an investor is known as risk profile.

When you have your risk profiling updated before investing, it helps you as well as your investment advisor to select specific assets for your investment portfolio which will correlate to your risk profile. Risk profile also helps in defining the potential threats to which the investor may be exposed.

Identification of your risk profile helps in taking corrective and pre-emptive steps for minimizing or avert impending losses. There is another term “Risk Tolerance” which is often confused with Risk Profiling. However, unlike risk profiling, Risk tolerance is the willingness of an investor to take risk.

Today we will take a look in to the importance of risk profiling before starting your investment journey. But first we need to understand the steps involved in risk profiling.

How Risk Profiling is Important for New Investors?

1. Risk Profile Assessment
   • Risk Capacity
   • Risk Tolerancey
   • Attitude to Risk
   • Risk Requirement
2. How is Risk Profiling Done?
3. Benefits of Risk Profiling for New Investors

So, without further ado, let us take a look at the risk profiling procedure and also understand about the importance of risk profiling for investors.

1. Risk Profile Assessment:

The sole purpose for which every investor invests is to achieve their financial goals. Risk profiling helps you understand about how much you risk they should take to achieve your financial goals versus, how much risk you can take. Your financial standing, i.e. the balance between your liabilities and assets is an important criterion for your risk profile evaluation.

Risk profile is assessed on four fronts. Let us take a look at each one of them to help you understand more about risk profiling.

• Risk Capacity: This is nothing, but the level of financial risk, that you as an investor, can bear comfortably based on your life situation. This capacity will change based on your age and other factors. As your age grows, your risk capacity will reduce for obvious reasons.
• Risk Tolerance: This is the psychological level of an investor which defines their ability to cope with the fluctuations in the financial markets. This includes your reaction and response to various different market situations like a correction phase.
• Attitude Towards Risk: The basic understanding that you as an investor possess about the concept of risk is defined as your attitude towards risk. It also includes the impact that the risk will have on your financial life.
• Risk Requirement: Setting up a financial goal is very important before planning your investment because it helps to understand where you are heading towards. If your goals are very aggressive, you will need to plan aggressive investments as well.

2. How is Risk Profiling Done?

Risk profiling is an easy process and will not take much of your time. Risk profiling is usually done using a questionnaire and a complex algorithm which analyze your answers to evaluate your risk profile. You can have your free risk profile analysis online and have an idea about your risk bearing capacity. Based on your analysis, you will be put into one of the three major types of risk profile.

Now this risk profile will help you or your advisor to plan your investment accordingly. For instance, if you are a very conservative investor, you should invest in instruments which have very low risk like debt funds, bonds etc. For aggressive investors, equity markets are the perfect place.

3. Benefits of Risk Profiling for New Investors

As a new investor, your risk profile will help you plan your investments as per your risk bearing capacity so that in any worst-case scenario, you will never loose beyond your capacity. Let us now understand how risk profiling is beneficial for new investors:

• It helps you in taking the right risk as per your requirement and capacity.
• Selecting the right investment opportunities inline with your goal and risk profile, so that you have a perfect balance of rewards and risk in your portfolio.
• It helps to identify your psychological reactions to surprises in your investment and how to keep your emotions away from your trading decisions.

Conclusion

Risk profiling is very important for every investor. Any investment planned without a risk profile analysis can lead to severe financial problems. If you are trading with the guidance of a certified investment advisor, they will never ever proceed with your investment without having an updated risk profile analysis. The markets are very volatile, and it is next to impossible to tame them. Therefore, it is always recommended to have your risk profile updated after every few years, because with your growing age, your risk profile also changes.

‍