Your investment plans must be based on various insights. The main source for these insights will be from your risk profile and the understanding of which asset classes meet your return expectations. At this point, it is important to understand that different products play different roles in portfolio construction. If returns are one side of the story, risks are the other. Balancing these is the key to a customized investor portfolio.
Your Investor Profile
The risks assumed in investments are dependent on your preferences and the returns calculated on your expectations. Given these factors, portfolios should be constructed such that they have the dynamism required to adapt to your profile and any changes to the same. Much like the juggler, different asset classes and products will be handled to create a well orchestrated portfolio that meets your needs at different points in time.
Your profile as an investor helps in the selection of combination of the asset classes required to invest keeping in mind your risk capacity and return potential.
Risks And You
When a wealth plan is made, the first step is to assess your capacity for undertaking financial risk. The capacity for risk depends on your responsibilities, objectives, personality and many other variables. To gain this understanding, the first step is:
Define Risk Profile
The risk profile is an individual’s ability to assume financial risk as part of his/her investment portfolio. The reward in assuming higher risks lies in the possibility of generating higher returns. However, your ability and willingness to take financial risks depends directly on you and your environment.
Risk and Your Environment
Deciding how much risk is good and how much is bad depends primarily on your impending responsibilities and feasibility of lifestyle. It is gauged by these factors:
Demographics such as age and life stage
Socio economic profile attributes such as habits and lifestyle
Though two individuals may have similar risk profiles, they may still differ in their attitudes to risk taking activities.
For example, consider Mr. Zaveri and Mr. Seth - both of the same age group and at a similar life stage. Mr. Zaveri goes through a market upswing or downswing with equal calm given his zen like personality, reacting very little to volatility. Mr. Seth on the other hand, reacts to fluctuations in the market and actively worries about it's impact on the economy.
Your attitude to risk is an extension of your personality and like any other form of self analysis this too requires you to assess yourself with complete honesty to make informed decisions.
Risk and Your Needs
Cognition of your risk capacity includes understanding your financial needs and expectations in specific detail. The following should add up to your overall investment goal:
Cash Flows - both in and out
Investment horizon for invested money
Objective or goals of the investment
An understanding of these dimensions is critical to form a view on the risk metric based on which investment decisions will be made. Investment experts worldwide have discovered broadly five different types of risk profiles illustrated in the image as
In order to make a suitable investment plan, it is important to find out the risk profile that defines your attitude and environment well. This helps in determining the level of risk your portfolio could assume.