Risk Profile

Before you choose an investment scheme or asset for your portfolio, you need to evaluate the investment option thoroughly. However, that is not the only research required. You should also be aware of your risk profile and factor it into your investment decision.

Unfortunately, not many investors are aware of the meaning of a risk profile, what it entails and why it matters. If you too are unsure about these aspects, read this article for a better understanding of the concept.

What is a Risk Profile?

A risk profile quantifies the ability and capacity of an individual to withstand different financial and investment risks. The concept of a risk profile also applies to assets, investment options and businesses. An investment’s risk profile explains how risky it is and how susceptible it may be to adverse price movements.

In this article, we delve into the concept of your personal or individual risk profile and why it matters in your investment decisions.

What makes up your Risk Profile?

Contrary to popular opinion, a risk profile is not determined just by how much risk you can take on. It consists of three different aspects or parameters, as outlined below:

• Risk capacity: The risk capacity is a financial measure of your risk profile. It is determined by how much risk your current financial situation can withstand. In other words, it measures your financial ability to take risks. For instance, if you are temporarily unemployed or if you have an unstable income, your risk capacity may be low.
• Risk tolerance: This aspect represents the level of risk that you are comfortable with. It is more emotional and psychological than financial. So, it may be the exact opposite of your risk capacity. For instance, you may have a stable income and a high capacity for risk, but if investing in risky assets makes you anxious, you have a low tolerance for risk.
• Risk appetite: This is the tricky part of a risk profile because it is more subjective. It reflects how much risk you are willing to take to meet your financial targets. Unlike risk tolerance, which is about how much risk you can handle emotionally, your risk appetite measures your willingness to withstand risk to achieve your goals.
  

Types of Risk Profiles

Based on the levels of risk tolerance, capacity and appetite, risk profiles can be any one of three types, as outlined below:

• Conservative risk profile: If you prioritise capital preservation over capital growth and wealth accumulation, you have a conservative risk profile. This generally means that your risk appetite and risk tolerance are low. Your risk capacity, however, may be high or low. Nevertheless, you may be unwilling to take on high levels of risk.
• Moderate risk profile: If you have a moderate risk profile, you may want to balance capital preservation and capital growth. This kind of balanced approach means that your risk tolerance and risk appetite are both moderate — neither too high nor too low. With a moderate risk profile, your portfolio may have a mix of high and low-risk assets.
• Aggressive risk profile: If you are an aggressive risk-taker, you undoubtedly have a high tolerance and appetite for investment risk. However, your financial capacity to take risks may (or may not) align with this. Without the required financial stability, maintaining an aggressive risk profile could be unhealthy for your finances.
  

Factors that help to determine Risk Profile

Your risk profile generally changes with time as it responds to a mix of different factors like the following:

1. Age: Your risk profile may be more aggressive when you are young and become more conservative as you approach retirement.
2. Financial stability: If you are financially stable, your risk capacity increases, making it possible to withstand an aggressive risk profile.
3. Investment goals: If you aim to earn high returns in a short period, you may need to be more aggressive. However, to pursue long-term goals, a more moderate approach may work.
4. Market conditions: The prevailing market conditions may also influence your risk profile. You may become more conservative in a volatile market and aggressive in a stable market.
5. Investment horizon: A longer investment horizon may allow you to be more aggressive initially and then take on a more conservative risk profile as the target date approaches.
6. Investment experience: Beginners may have a lower risk tolerance than seasoned investors, who may be more comfortable with risky investments.

Conclusion

Now that you know the meaning of a risk profile, you can assess yours before you make any investment. If you are looking for a mix of high-risk, low-risk and moderately risky assets without over-diversifying your portfolio, mutual funds may be a suitable choice. This is because you can compare mutual funds in different categories like debt, equity, hybrid and money market funds. You can then find the mutual fund scheme that aligns with your risk profile and expected returns.

The Bajaj Finserv Mutual Fund Platform makes investing easier for aspiring investors. With 1,000+ mutual funds to choose from and an easy, hassle-free investment process, you can quickly make an informed decision and start a SIP or make a lump sum investment in the fund of your choice.

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