Risk profiling is an exercise to determine how much risk is appropriate for an investor. A risk profile is subjective. It is insensible to assume that each person will have the ability or objectivity to determine their risk profile appropriately. As we have learned previously, Risk profiling can be carried out by understanding the different factors that can affect our risk tolerance and appetite. This is done by asking several questions as part of a structured data gathering exercise. Examples of few such questions are:
1) What is your age?
A young investor will have a higher risk taking capability than an older person due to the fact that he has more time on his side
2) How many earning members are there in the family?
If the number of earning members is high then risk taking capacity goes up but if there is only one earning member then he can have lower risk taking capacity.
3) How many dependent members are there in the family?
This can affect your expenses and therefore should be kept in mind.
4) How stable are the income streams in the family?
If the job is a permanent full-time one as compared to a freelance consultant then the person will be having a higher risk taking capacity.
5) What is the level of the investor’s current wealth, in relation to the fund requirement for their various needs?
Already if the investor has gathered substantial assets then he can take on higher risk.
6) What is the liability and loan servicing requirement of the client?
If the investor has single or multiple loan EMI running then a major portion of income gets eaten up by such liabilities leaving little surplus for investing and taking risk.
7) If the market were to fall down by 10%, how will you respond?
The investor who believes in increasing his position when the market falls is obviously comfortable with risk and losses. If a market fall were to trigger an exit from the investment with whatever can be recovered, then the investor is not a candidate for risky approaches to investment. Such questions help in understanding the psyche of the investor and accordingly asset allocation can be customized for the investor.