What is your risk profile?

The risk profile of an investor is difficult to gauge because it oscillates with market moods. When the market is on the rise, even the most risk-averse start buying stocks. A sharp correction leads to panic selling, even by risk-takers.

No wonder, the first thing a financial planner wants to know is his client’s risk profile. It helps him direct investments. A person’s risk profile is a combination of his attitude towards asset classes and his investment tenure and objectives.

Many wealth management companies use psychometric testing. “These tests could be a starting point. But risk profile cannot be mapped without considering the investible amount and the tenure of investments,” said Sumeet Vaid, a certified financial planner.

An investor is given a set of questions with four options. Each answer has points and the sum total defines the risk profile. The person is then defined as conservative, moderate or aggressive. Some use five categories – very conservative, conservative, moderate, aggressive and very aggressive.

While there are a large number of wealth management companies and websites that can help you gauge your risk profile, here’s some help if you wish to do it on your own.

STEP 1
Investment horizon: Whether it is equity, debt, gold or property, you need to take a call on the tenure and accordingly choose the asset class.

STEP 2
What is your investment goal? The goal has to be matched with the investment horizon. For instance, if you wish to purchase a car in the next three years, investing in equities is the best option. However, if you want to buy a flat in six months, you may have to compromise on returns to ensure there is no erosion of capital. In such circumstances, a fixed deposit is ideal.

Let’s assume you are saving for retirement. The first obvious question is to ask how much money do you need to maintain a decent lifestyle. And remember, 15-20 years later, when you retire, inflation would have reduced the value of your savings significantly.

Say you want to retire 20 years later with Rs 1 crore. If you invest in equities, you can achieve the target by saving Rs 10,000 every month for the next 20 years, assuming an annual rate of return of 12 per cent.

But if you opt for a fixed deposit at 8 per cent, the monthly saving has to increase to Rs 16,900. Also, equity returns will be tax-free whereas returns from debt funds will be added to your income and taxed accordingly.

If the investment horizon is between three years and five years, investing in equity for the first three years and then shifting to debt slowly can help get decent returns. That is, a young person wishing to get married and buy a property and a car needs to be aggressive in the first few years.

For investment goals of less than three years, debt is ideal. One could take the route of fixed deposits or short- and medium-term debt funds. However, if you want to make money aggressively, investing in good balanced funds can shore up returns. This is because they invest a part of their money in equities, which increases returns. Such investment goals are typically related to purchasing a car or planning a holiday.

For ones who are unsure about investing in equities, it’s best to start with exchange-traded funds (ETFs) that have Nifty or Sensex as the underlying index. “This will ensure that investments are in large-cap companies. ETFs are the least volatile among pure equity products. They also give returns on at par with stock market indices,” said Gaurav Mashruwala, a financial planner.