Very often, people jump into investment products offered by financial advisors by merely looking at the rate of return provided. However, there are a host of other factors that investors often fail to assess. One of the most significant factors among all is a risk. In investments, along with returns, your risk profile remains one important consideration. Knowing your risk profile helps you understand how much risk you can take vs how much risk you should consider. Hence, having an idea of your risk profile is essential before blindly hawking into any financial products.
So, the question is- how can you evaluate your risk profile? The following metrics will help you create a risk profile understanding:
1. Personal Profile
Age is a vital factor that governs the risk profile of an investor. If you are a young professional with minimal responsibilities and long investment duration, you can think of putting more money in riskier investments. However, this might not be suitable if you have family dependents like parents, wife, and children. In such a case, you may want to look at investments catering to both, return as well as protection. Financial responsibilities such as your children's education and marriage and your current financial situation will remain vital in deciding your risk-taking ability. If you have enough funds to meet your short-term goals, you can expose your portfolio to high-risk investments.
2. Professional Profile
Your income is an important determinant to assess your risk tolerance. If your monthly income is high enough, you should not mind taking higher risks and vice-versa. It is because small setbacks in your portfolio will not affect your capability and ability to invest. Additionally, the industry in which you work can also determine the stability of the income. For instance- If you are working in a start-up, you should not be an aggressive investor as compared to someone working in a stable and reputed firm.
3. Family Wealth
If you have family wealth, the question is how much money you can invest or spare? If your family wealth is the surplus money that you can put to good use and earn more, then you can afford to take a high risk by investing that amount in riskier instruments like equity. However, if the loss of that wealth will stretch your finances to the breaking point, then you should opt for capital protection instead of growth. In such a case, park your money in more conservative instruments like debt funds, and balanced funds.
4. Current Investment Portfolio
Your current portfolio represents the investments made by you over a period. If you have invested in very safe instruments, to reduce the riskiness of your portfolio, you might want to give it a thought. Because, in doing so, you are giving up some potential returns and you would also need to save much more to meet your long-term financial goals.
Hence it is best to adopt a goal-based investing exercise and make changes in your investment portfolio. Thus, if you have time in hand, you can take higher risk and can invest in equity-related investments, as a longer horizon ensures that short-term volatilities do not impact the final return on your investment. On the other hand, investments meant to suffice your short-term goals can be put in into liquid investments or fixed income category.
5. Understanding of The Equity Market
Investing in the knowledge of the market is your best investment. Thus, when you plan to make investments, it is essential to invest as per your understanding of the market and long-term sustainability. Moreover, high-risk equity investments require one to have adequate market knowledge. So, know about investments that can cater to your needs (according to your risk profile) and gather information about them.
If you are an aggressive investor and aim for the protection of your family too, investment in Market linked instruments like unit-linked insurance plans can be a great idea. Considering aggressive ULIPs, which only focus on equity investment, will require a thorough understanding of the equity market. A money investment plan like ULIP can provide you with the dual benefit of market-linked return and insurance protection. Also, it can be a great vehicle for wealth creation, children's education and retirement planning.
Risk profiling is extremely useful for you, even more so if you are a beginner, as it helps set the right expectation and gives an excellent opportunity to get a glimpse of your aspirations, and tolerance.
Getting good returns from your investments is all about the risk-return balance that you can handle with ease. So, next time you hear about an investment opportunity, ask yourself whether it suits your risk-profile or not!