Why you should understand your risk profile before investing

Why you should understand your risk profile before investing

“With great power comes great responsibility” — this is a famous quote from the movie Spiderman. This applies to almost everything we do. There are always two sides of the same coin. This principle applies even to every investment decision we make. An investment starts with two factors — one is the return as every investor wants more and more, and the other is risk, which everyone wants to avoid. You must understand that these factors go hand in hand and it is not possible to eliminate the risk while getting higher returns, but you may reduce it by effective planning. Although it is easy to understand the returns by looking into the instrument’s past performance, it is hard to analyse the risk profile of the investor. Someone who understands the risk and analyses his/her own profile will be rewarded by finding the right instrument to invest in.

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“There is no such thing as a free lunch”. Had it not been the risk involved in investments, then every investor would have probably liked to invest in a probable high-return instrument. However, it is the risk which keeps them segregated. While investing, looking for the returns only is like seeing the half-truth, and the half-truth may give you more bruises than a complete lie.

What if you ended up investing in an FD? Then you may remain bothered about not beating the inflation, or what if you invested in aggressive Mutual Funds for higher returns when every equity market move gives you a headache? In such cases, your investment may not be good for you.

Every investment is done to ease the investor’s life, and knowing the risk appetite is the first step one should take before investing. So what is Risk? Risk is determined as, how much you can afford to lose or how much investment deterioration you can see in your investment portfolio. Analysing your risk appetite and comparing it with the returns will bring the investors onto a path which is right for him/her. Every single person has a different risk profile as the risk appetite depends on psychological factors, loss baring capacity, investor’s age, income & expenses and many such other things. One investment instrument may be good for an investor, but may not be good for others. It all depends on the risk profile. Knowing your risk profile would lead you to the right investment, but if you don’t go for it first, then you are taking your first step in a wrong direction which may lead you to uneasy situations. For instance, if a slight downward movement in your equity/mutual fund portfolio gives you stress, then you may end up eroding your investment by selling it impulsively.

A person in his/her early 20’s may invest in a comparatively higher risk investment instrument where returns are higher, but this decision cannot be taken by a retired person living on his/her pension as they can’t afford to lose their only living option. For the former person, it may be good to invest in Mutual Funds or Equities where he/she can expect a higher return with comparatively higher risk, but for the latter, an FD or a debt instrument may be a good option to invest in. So this is how an investment decision should be taken after analysing both the risk profile and returns and not by luring only into higher returns where you may trap yourself into if you don’t know your own risk profile.

So how your risk profile would help you with the right investment option? Here’s how* –

Risk profile/appetite is subjective, it changes with the scenario. It is linked with the current events happening around. In a rising equity market, one can say that he/she is willing to take higher risk to get higher returns, but in a falling market, the same person may rush to invest in a fixed income instrument. Knowing their risk profile is a must for an investor, and it would be even better if he/she analyses it frequently over a period of time.

For instance, an investor starts investing in his early 30’s for his retirement at the age of 60. He earns good income for his living expenses, have an insurance policy for the unforeseen outcome, then he may set a highly aggressive profile to invest in equities and mutual fund as he has a very good long-term period to multiply his investment, but as soon as his retirement age nears, he must move some investments from equities to debts or to any fixed income instrument. In his early 30’s, he can afford to lose some part of his investment, but now when he is about to retire, he cannot afford to drain his investment in a high-risk portfolio.

One cannot change the behaviour of the market, but one can adjust his/her own behaviour accordingly. You cannot change the returns of PPF, FD or Mutual Fund, but you can change your own returns by investing in different instruments according to your risk profile, and that is where knowing and understanding you own limits/risk profile will bear fruit.

Set your risk profile first before investing in any instrument, then select investment options according to your profile. Evaluate your risk appetite regularly over a period of time and adjust your portfolio correspondingly. This process will help you keep your investment period at ease, and you will be ended up investing what is right and tailored for you. After all, who among us don’t like a tailored service? It could be a time where one is not being able to access the right risk profile for him/her, then he/she must take the services of a financial advisor who may not only help the investor know the risk appetite but also help him/her find a suitable investment instrument to invest in.

 

Source:- financialexpress

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