Wealth creation is every one’s dream. We Indians are born savers. We grew up seeing our parents, grand parents save from their income year-on-year. Most of us came from the middle class families. Middle class is the most focused and disciplined investor. This group work hard for the livelihood. And try to save maximum to safeguard family’s future. Our parents mostly saved in the traditional financial products. Their aim was to keep some amount of their income away to face any emergencies. They never thought of creating wealth by that saving. Their dreams were limited. They were more than happy in their present state of income ladder.
But in our times our desires, dream and aspirations are increasing day by day. We want to climb up the class ladder. Those who are low middle class want to be upper middle class. Upper middle class want to be HNIs. And HNI’s want to be multibillionaire. We find it difficult to just satisfy our wants through our regular income. We try hard to multiply our wealth. But reality can we build wealth just by saving ? Merely Saving in bank account will we create wealth? The answer is No. We have to make our savings work for us. This process is called INVESTING. But investing without a goal means investing randomly which may not be sustainable and can be stopped any time if any emergencies happened. So your investment should be based on Goal-based Investment strategy.
One of the most important step the investor should take before starting investing is to undergo Risk Profilling.
What is Risk Profilling?
Risk profilling s a process of defining investor’s risk tolerance – attitudes, values, motivations, preferences and experiences.
The Financial Planner seeks help of Risk Profilling Questionnaire in understanding the risk tolerance levels of the investor. Risk Tolerance is the assumed level of risk that a client is willing to accept.
Financial Risk Tolerance can be split into two parts.
Risk Capacity : the ability to take risk
This relates to investor’s financial circumstances and their investments goals. Generally speaking investor with higher level of wealth and income (relative to the liabilities they have) and a longer investment term will be able to take more risk, giving them a higher risk capacity.
- Risk Attitude: the willingness to take risk
Risk attitude is more to do with the individual’s psychology than with their financial circumstances. Some investor will find the prospect of volatility of their investments and the chance of losses distressing to think about. Others will be more relaxed about those issues.
Risk tolerance is typically measured using questionnaires that estimate the ability and willingness to take risks. The responses of investors are converted into a score that may classify them under categories that characterize their risk preferences.
Investors are classified in following 3 main categories based on their risk preferences.
- Conservative Investor :
- Do not like to take risk with their investments. Typically, new to risky instruments.
- Prefer to keep their money in the bank or in safe income yielding instruments.
- May be willing to invest a small portion in risky assets if it is likely to be better for the longer term.
- Moderate Investors.
- May have some experience of investment, including investing in risky assets such as equities.
- Understand that they have to take investment risk in order to meet their long term goals.
- Are likely to be willing to take risk with a part of their available assets.
- Aggressive Investors
- Are experienced investors, who have used a range of investment products in the past, and who may take an active approached to managing their investments.
- Willing to take on investment risk and understand that this is crucial to generating long term return.
- Willing to take risk with a significant portion of their assets.
These are the three broad categories of the investors. Sub categories can be
- Moderately conservative
Want reasonably stable growth and/or a moderate income and are willing to accept a moderate level of risk. Your investment term is a few years or more.
- Balanced
Are looking for a diversified portfolio that contains a balance of security and the potential for growth. You’re willing to accept a certain level of volatility and will typically be prepared to invest for five years or longer.
- Moderately aggressive
Want to invest in a broad range of asset classes but with a greater focus on growth rather than income. You’re willing to accept volatility in the value of your investments in return for potentially higher growth, and you could be looking to invest for up to 10 years.
Financial Advisors take into account the risk preferences of the investor while constructing an investment portfolio. The aim of risk profiling in financial planning is to not only determine the financial risk you have the capacity to take, but also the level of risk you are willing to take.
DIY(Do It Yourself) investors should follow the same steps for assessing self risk tolerance level.
Risk profiling is thus very important to design a financial plan with appropriate asset allocation most suited to meet your investment requirement and as per your individual risk tolerance. Investors should use a risk profile as a way to mitigate potential risks and threats of the financial products they have chosen for the investment