Understanding Risk Profiling
Investing and fitness are related, they go hand-in-hand. You do certain basic things before you decide your ﬁtness routine – check your weight; gauge your stamina, ﬁgure the time you can spend each day working out; and your overall expectation out of a ﬁtness regime. All this helps you devise the ideal ﬁtness plan depending on your weight, BMI, expectation, etc.
Investing is similar. Before you consider investing in any ﬁnancial instrument, you must know how much risk you’re ready to take. Investing in the ﬁnancial market carries some inherent risk – which can be classiﬁed under systematic and unsystematic risk.
Systematic Risk comes from the inﬂuence of external factors on an organisation – those which are not under the control of the organisation. It includes risks such as interest rate risk, foreign exchange risk that are at a macro level which the organisation has no hold on.
Unsystematic Risk refers to the internal risks that an organisation is exposed to which are usually within the control of the organisation. These include business risk such as management decisions, ﬁnancial risk such as proﬁts and losses and operational risk which pertains to the manpower that a company employs. While these are the overall risks that concern the ﬁnancial markets, you must, at an individual level recognise yours before you start investing.
Risk profiling is important for determining a proper investment and asset allocation for a portfolio. Every single person has a different risk profile as the risk appetite depends on psychological factors, loss bearing capacity, investor’s age, income & expenses and many such other things.
Here are the most common risk profiles for investors:
Seeking safety of capital, minimal risk and minimum or low returns
* Possible Allocation – Equity: 0-10%; Debt and others: 90-100%
Willing to take small level of risk for potential returns over medium to long term
*Possible Allocation – Equity: 10-30%; Debt and others: 70-90%
Looking for relatively higher returns over medium to long term with modest risk
*Possible Allocation – Equity: 40-60%; Debt and others: 40-60%
Seeking to maximise returns over medium to long term with high risk
*Possible Allocation – Equity: 70-90%; Debt and others: 10-30%
Willing to take significant risks to maximise returns over the long term
*Possible Allocation – Equity: 90-100%; Debt and others: 0-10%
Note: *This is a model portfolio for understanding the concept and not a recommendation (#others means, fixed or low-risk investment)
Your risk profile may change over time, depending on changes in your life cycle. Maybe your income changes or you have new goals, etc. Hence, what was right and worked for you at a younger age may not be the same when you turn 45 or 50.
Mutual funds help you invest across asset classes as per your risk appetite. If you are investing in debt or equity through mutual funds, you can choose a mutual fund category depending on your risk appetite and time horizon.
Your financial advisor can help you take a short and simple risk assessment to help you determine which category you fall under. Based on this, he/she can determine what proportion of your portfolio should be invested in which asset class.
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Disclaimer: This information is for general information only and does not have regard to particular needs of any specific person who may receive this information. L&T Investment Management Limited, the asset management company of L&T Mutual Fund or any of its associates; does not guarantee/indicate any returns/and shall not be held liable for any loss, expenses, charges incurred by the recipient. The recipient should consult their legal, tax and financial advisors before investing. Recipient of this information should understand that statements made herein regarding future prospects may not be realized or achieved.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.