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Determining your risk profile

25 February 2022
Determining your risk profile

Before you jump into investing it is integral that you assess what your risk profile exactly is. In investing, a risk profile is an individual’s ability to withstand risks such as market fluctuations. Your risk profile is important because it determines what your investment strategy should look like and how your assets are allocated within a portfolio.

Risk can also be essentially thought of as the trade-off between risk and return, which is to say the tradeoff between earning a higher return or having a lower chance of losing money or vice versa.

This is why when you take your money personality quiz on Stack, we ask questions about how comfortable you would feel if the markets you invest in were to dip, or on how you would react if they were to show other signs of temporary stagnations or fluctuations. Would you invest more? or would you panic to cut your losses?

And while market fluctuations are dynamic and can be justified by the impact of various external factors, risk profiles are a bit more tricky. Not only do they rely on your age, mode of employment (i.e stable, seasonal), debt, Lifestyle and income implications etc. but also how you operate on a more psychological level.

For instance say you earn a passive income that you consistently invest in the Indian stock market, with hopes of building significant wealth. Given the longer time horizon, you should typically not be worried if the market faces a temporary downturn as it eventually corrects itself, restabalises and since historically the Indian market has always shown an upward trend. But you may be tempted to cut your losses at where they are instead. And you would not be alone in doing so. Behavioural finance analysts and macroeconomists agree that despite knowing the right strategy we often fall prey to groupthink when it comes to investing.

So how do I mitigate my risk?

One of the best and safest ways to control risk is through asset allocation. Asset allocation simply put, refers to how much money you are investing in different investment vehicles such as stocks, bonds, fixed income, debt funds etc.

Generally, market dependent asset classes such as equities and certain mutual funds are higher in risk while fixed-income securities and bonds offer stable (although lower) returns.

How does Stack assess my risk?

Stack takes into account a combination of your goals, investment objectives, income, debt history, time horizon, your personal investment behaviour, any past investment experience, and general tolerance to risk - to assess which risk profile you best fit into.

The Growth Profile

You may identify with the Stack Growth profile if your investment objection is steered towards high-risk high-return. This profile serves the intent of maximising growth and building wealth. While we expect this portfolio to have the highest returns, it also carries with it the highest volatility.

The Growth risk profile is right for you if:

  • Your are primarily focused on pursuing above-average portfolio appreciation over time
  • If you can withstand seeing large fluctuations in your account, with relative ease.
  • If you wish to build wealth and grow your money considerably while undertaking the tradeoff of high risk, over the course of your tenure period.
  • If your investment through Stack is only a considerably small portion of your wealth or any extra money you wish to grow, and you don’t actively rely on it as a source of income.
  • If you are an experienced investor with a small portfolio size such that any large losses will not derail your overall investment strategy.
  • You wish to build a portfolio that has exposure to various asset classes but which is heavily invested in equities

The Balanced Profile

You may identify with the Stack Balanced profile if you wish to incur medium-risk. It is ideal for individuals whose investment objective is a combination of growth as well as protection of their capital. While you do not expect the highest expected returns there are to offer, people who fall under this profile certainly enjoy a much-needed safety net during a market decline. That being said, with the Balanced profile there is still a moderate level of risk being undertaken.

The Balanced risk profile is right for you if:

  • You strive to strike a balance between risk and returns or value higher returns scaled to an agreeable amount of risk.
  • You can withstand some fluctuations in your account.
  • You wish to grow your capital adequately but aren't comfortable with super high fluctuations.
  • You have accumulated a considerable corpus of money and wish to further grow it to build wealth.
  • You are a new investor and are apprehensive of large amounts of risk but still want significant returns in the long run.
  • You wish to build a portfolio that primarily includes a balance of investments in bonds and equities.

The Conservative Profile

You may fall under the Stack Conservative Profile if your investment strategy hinges on taking the most minimal amount of risk. It is ideal for individuals who have possibly accumulated a significantly sizable corpus of wealth and wish to limit fluctuations and park it while still trying to generate returns that beat the rate of inflation. It could also be ideal for individuals who are extremely sensitive to risk and rely on their investments as a primary or passive source of income.

This is the ideal profile for you, if:

  • You are only comfortable with small fluctuations.
  • You are building up a portfolio that is primarily focussed on portfolio stability and preservation of capital.
  • You are highly apprehensive of risk but still want to grow your money better than a savings account or FD.
  • You wish to build a portfolio that primarily includes investments in cash and bonds with some allocation in equities.

Conclusion:

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 age 25 may not be the same when you turn 45.

Therefore, it’s important to assess your risk profile periodically since this may shift during your lifetime depending on changes in your life situation (when your financial obligations get fulfilled, you have new financial obligations, your income levels change, etc.)