A Financial planner prepares a financial plan to help his clients achieve their goals. To accomplish financial goals, means that there is sufficient money available at the required time to meet that financial commitment. In other words we can say financial planning helps in having the required sum of money when needed. For we all must believe that money and medicines should always be served in time.
On the basis of your present financials and goals, the financial planner starts to prepare a plan for you. He takes into account various factors such as the time available for each goal, present investments, income, inflation and your risk profile to lay down a feasible plan for you. Here we shall talk about Risk Profile of an investor.
What is a risk profile? To understand what is risk profile; we must know what is Risk? Risk is the uncertainty that exist as to what the real outcome would be if you acted in a particular manner. In financial terms it may imply, the amount that you may stand to gain or lose on the risk taken by you. This also brings forth the concept of Risk tolerance. There are various factors that go on to decide if your ability to take risk matches your capacity to take risk.
In short Risk profile help to assess:
- Your attitude to risk
- Your capacity to take risk
Your attitude to Risk: It is the measure of your personal comfort with risk. Are you the kind who is willing to take high risk to have higher returns or would you prefer having lower returns, but would look for safety of your principal invested amount? A person’s attitude to risk comes from his family’s way of investing and his relationship with money. We may state here that a person’s attitude to risk is also related to his present circumstances. To illustrate: One may adopt a very conservative approach to risk if he has been through extensive losses. Once bitten, twice shy!
Your capacity to take risk: It refers to your capacity to sustain to an unfavourable outcome, without disturbing your present condition. In case there is a short term loss in your investment it does not upset your expense budget or your lifestyle largely. The capacity to take risk should be viewed with the time frame available for an investment. In case you have a need for money in short period of time, it would be safer to put it in a bank fixed deposit, rather than investing in equities. But where your goal is for a longer tenure, equities could be the instrument to beat inflation and would fetch you better returns.
It has been observed in few cases, where a person has a capacity to take risk, but does not have an attitude to take risk, and in many cases it is vice versa. Both the cases are not healthy.
People behave differently at different times.
- Phase of life: A person’s risk tolerance level depends on the phase of life he is in. Rahul a young man age 26 years , with an earning of Rs. 5 lac pa, and with no dependants may be very comfortable to take a high amount of risk as compared to Nikhil age 32 years, earning of Rs 5 lacs pa a with a child of 2 years.
Same Rahul may not be in the same comfort zone once he has dependants and income and expenses go uncontrolled.
2. Financial Position: A persons financial condition plays a great role is deciding whether he can or cannot take risk. For example Mr. Mali with a home loan of 80 lacs and fairly constrained on the liquidity front may not find it easy to adapt to an aggressive investing strategy.
Typically every investor can be categorised under any one of the categories.
Conservative: A person who is not willing to take any risk and is happy with low or moderate returns. He is more interested in the safety of the principal amount invested. He would usually be comfortable investing in, Bank Fixed deposits, Bonds.
Moderate: A person who is willing to take a calculative risk, keeping in view the market volatility, he can look to getting better returns. He would be fairly comfortable with mutual funds and equities.
Aggressive: A person who is willing to take big amount of risk and looking for higher returns. He may invest in direct equities, commodities and even derivatives.
A Financial planner lays down a questionnaire that is required to be completed by you. He makes a judgement about your risk profile before he decides on the type of investment and the asset allocation that may be needed by you to fulfil your goals. He may categorise you as a conservative, moderate or aggressive in your perception to risk, however he would devise a strategy for you; conservative or moderate after looking at your goals, income, the time frame available for each goal and after collating your assets and liabilities. Thereby, he assures you to a better management of your resources.