If you are reading this, you have probably already started trading or thinking about starting very soon. Before you read further, let’s make it very clear that stock market trading has its fair share of risks. Entering this highly volatile market can prove to be a disastrous mistake if you are not aware of managing the risks through proper analysis, hedging, and adequate precautions.
Investing in volatile stocks can erase a significant portion of your trading account in minutes. This can lead to huge losses which can end up in unwanted debts, especially if leveraged. To avoid this situation, it is better to understand the risk that you are capable of bearing before investing.
One of the easiest ways to understand the risks is to get a risk profile analysis. You can approach any SEBI certified investment advisor to get this analysis. It hardly takes a few minutes, but the outcome can help you understand your risk appetite.
What is a Risk Profile Analysis?
A risk profile analysis is aimed at evaluating the risk appetite of any person who wishes to invest or trade in the stock market. This usually comprises of a set of 15-20 questions, all of which help in identifying the assets, liabilities, investment horizon, dependencies, and other aspects which have a direct or indirect impact on the financial strength. The questions may be similar, but the risk score is calculated as per the proprietary calculation formula that has been defined by the investment advisor. This is usually kept as a trade secret and the actual algorithm is known only to a select few within the organization. SEBI has made it mandatory to get your risk profiling done before investing, which is very much like the analysis of CIBIL score before getting a loan.
Cost of Getting a Risk Profile Analysis
A risk profile analysis is usually conducted free of charge. It is the investment advisor’s fiduciary right to educate investors and traders about the potential risks and applicable policies before they actually enter the market. Once a risk profile is conducted and the results of the analysis are disclosed, you can choose to proceed on your own or subscribe to their stock market recommendation service based on the risk appetite identified by them. Every certified broker and investment advisor will always get your “risk profile analysis” done before proceeding for any trade.
Results of a Risk Profile Analysis
A risk profile analysis will bring forth 3 common outcomes, namely, low risk, high risk, and high risk. If you get low risk, then you should be worried because your liabilities and investment horizon will allow you to take less risk in the market and hence, your expected returns will always be less.
A medium risk appetite will indicate moderate returns with respect to the investments made by you in the stock market. Hence, the expected returns will be moderate. For high risk appetite, your financial conditions indicate that you can take greater risk and the subsequent risk-reward ratio will be higher.
Needless to say that the result is only indicative of the outcomes of answers provided during the evaluation. Any incorrect answer will lead to wrong analysis and this can severely impact your trades or investments in the market. The trades made after a risk profile analysis do not provide any guaranteed return. Factors like preferred trading or investment style, investment horizon, emotional decisions, and straying from suggested recommendations can lead to unexpected outcomes.
Do’s and Don’ts of Risk Profile Analysis
Getting a risk profiling done is a very simple and quick job. It identifies the acceptable level of risk an individual is prepared and able to accept. It evaluates you on certain factors including age, income, assets, liabilities, debts etc. Every individual has a different risk profile based on all these factors.
When you approach an investment advisor or a broker to get a risk profile analysis, you should:
• Provide honest answers with utmost clarity
• Obtain all the details of your finances, especially liabilities and dependencies
• Understand and fix the amount of investment you can make in the stock market
• Understand the duration of investment wherein you will have to stop yourself from withdrawing the investment amount from the market before maturity
• Get a demat and trading account before considering making your next move towards stock market investments.
When you approach an investment advisor or a broker to get a risk profile analysis, you should not:
• Undertake any liability once the results of the risk analysis are provided. In case any debt is incurred, a fresh risk profile analysis should be obtained
• Use any credit card or loan to pay for your investments because it will offset any estimation of your liability and you could end up incurring unnecessary loss due to unplanned trades
• Ignore the results of the analysis because it will only cause harm to your hard earned money
The Next Steps
The risk profile should always be updated before planning any new investment because it varies almost daily. For example, you had a risk profiling done last week when you had no debts. You used your credit card today for buying that feature packed smartphone you always desired for. So now you own a debt to the card issuing bank. This debt can affect your previously done risk profile.
It is an offence for all the SEBI certified advisors and brokers to proceed for investment or trade with any client or customer without getting his risk profiling done. Your advisor will accordingly plan your trades and portfolio based on your risk profile, so that in case of a loss it won’t exceed your financial capacity. Stock market is full of risks and volatility, a green portfolio can convert into a red one in no time, so its better to get your risk profile done and updated to avoid unbearable financial losses.
Risk profiling is your CIBIL score for investments. It defines how much risk can you take in the stock market. It is pretty evident that when you enter the market in one form or the other your investment is always at risk. If you have invested in the market or you are planning to invest, get your risk profile updated if not done because your risk bearing capacity changes frequently. An updated risk profile is amongst the key factors behind a successful investor.
In an earlier post, we have discussed about the various risks that can affect your investments. Do read it if you want to understand the various risks that your stock market investment may be subjected to.
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