What is a Risk Profile?
A risk profile is a personalised profile that takes into account your financial goals, investment timeframe, and the level of risk you’re comfortable taking. It’s important to realise that there’s no such thing as a right or wrong risk profile; your risk profile is just yours. It’s whatever you are comfortable with that best meets your needs.
Investments are risky business! You should review your risk profile on a regular basis because your attitude toward risk may change. You may want to take more risks or reduce risk and move into a more conservative profile.
Whatever type of investor you are in terms of risk profile, be true to yourself in order to tailor the right investment strategy.
Why You Should Know Your Risk Profile Before Investing
“With great power comes great responsibility” — this famous Spiderman quote holds true for almost everything we do. This principle even applies to all our investment decisions.
Every coin has two sides. An investment starts with two factors: the return, which every investor wants to increase, and the risk, which everyone wants to avoid. You must understand that these factors go hand in hand and that it’s not possible to eliminate risk while increasing returns, but you can reduce it through effective planning.
Honestly, there is no such thing as a free lunch. Everyone would have chosen to invest in a high-return instrument if there were no risks involved. It’s the risk which keeps them segregated. Only looking for returns when investing is like seeing the half-truth, which may leave you with more bruises. That’s why knowing your risk profile is important.
What is Risk and How it Affects Investing
Every investment is made to make the investor’s life easier, and knowing one’s risk profile is the first step before investing. So, what exactly is risk? Risk is defined as how much money you can afford to lose or how much investment deterioration you can expect in your portfolio. Every person has a different risk profile because the risk appetite depends on psychological factors, loss bearing capacity, investor age, income and expenses, and many other factors. You would be able to make the right investment if you knew your risk profile.
For instance, a person in his early 20s may invest in a higher-risk investment instrument with higher returns. However, a retired person living on his pension can’t make this decision because he can’t afford to lose his only source of income. For the former, it may be best to invest in Mutual Funds or Equities, where he can expect a higher return with a higher risk, whereas, for the latter, an FD or a debt instrument may be a better option. So, this is how an investment decision should be made after analysing both the risk profile and the returns. Otherwise, you may trap yourself by luring only into higher returns.
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