Risk Profiling and its Importance

By Banyan Financial Advisors

The term risk profiling may often be heard by investors when talking to their financial advisors or wealth manager. However little would an investor know at times as to what would ‘Risk Profiling’ mean and its associated advantages.

Simply putting it, Risk Profiling aims to identify how much risk can an investor take on his money. The objective of identifying risk is to arrive at an appropriate investment mix which would align with the objectives of an investor.

How is Risk Profiling done?

The formal way of performing risk profiling is by creating psychometric questionnaires which contains several questions trying to assess the background of the investor. An example of the objectives being assessed are as follows:

  • Aptitude towards risk taking
  • Do you have any dependents
  • Any financial commitments in the near-mid-long term.
  • Age of an investor.
  • Source and amount of regular income
  • Stability of job.

On a general basis, having dependents, old age, unstable job or near term financial commitments would result in a low risk profile for an individual. On the contrary no dependents, no short term financial commitments, young age, stable job with regular source of income would result in profiling an investor as a High Risk. A high risk taking profile investor can invest into high risk / volatile investment products like Equity / stock markets. A low risk profile investor should invest in debt / fixed deposit products as the element of volatility is low and returns are more or less stable and predictable.

The more honest an individual is while answering the set of questions, the more aligned would be the financial planner’s advice to meet the individual’s goal. Once such an assessment has been performed by the financial planner, he can take a decision upon the risk profile of an individual and suggest a suitable financial / investment plan taking into account the goals and time horizon of the investor

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