What is Risk Profile & Risk Tolerance? How to know your risk profile?

3 min read

In this article, we will discuss what is risk profiles, and the pointers one needs to look after to understand his/her risk profile. So, let’s get started.

Risk Profile

  • A risk profile is an assessment of an individual’s willingness and potential to take risks. It is important for determining a proper investment asset allocation for a portfolio.
  • There are two parts of risk profile one is risk capacity and another is risk tolerance, combine two will understand our risk profile.
  • Risk capacity is the most important part, it is judged based on 4 things age, savings, job/work stability, and assets/liquidity.

Factors to know your risk profile:

1) Age:

  • The higher the age is, the lower the risk-taking capacity.
  • Generally, at the age of retirement or retired people used to have lower risk-taking capacity because they don’t have a fixed income source while young people whose age is around 20-30 their risk-taking capacity is high because mainly people from this age have less responsibility, depend on parents, and have nothing to lose.

2. Savings:

  • Higher the saving, the more risk capacity.
  • If we save only 10%- 20% and are not able to meet our goals like children’s education
  • And retirement goals from these savings then we will not able to take risks.
  • But if someone is saving 50%-60% it will be easy for them to manage their goals and make investments with having more risk-taking capacity.

3) Job/Work stability:

  • More stability, more is the capacity.
  • What kind of job one is doing and in what industry he/she is doing
  • if the job is stable then the risk-taking capacity is more.
  • Generally, people with government jobs or working in IT companies have more risk-taking capacity
  • Entrepreneurs have less risk-taking capacity because of the stability.

4) Assets/ Liquidity:

  • The higher the assets you have the more is risk capacity.
  • If someone has a high amount of assets and they know that all their goals can be met from these assets then the risk-taking capacity of that person will be high.

Risk Tolerance

Risk tolerance is the level of risk an investor is willing to take.

It is different from risk capacity as some people have high-risk capacity but they are not willing to take many risks. There are three types of risk tolerance levels:

Conservative- The person whose risk-taking capacity is high or low doesn’t matter but is not willing to take risks is called conservative or low-risk to reliance folks.

Moderate- People who panicked not sell during the falling period are moderate risk tolerance. As they are worried about the falling price but not taking action means they are taking risks.

Aggressive- People to whom it doesn’t matter whether the price is falling or going up have a high tolerance level. Generally, these are the long-term investor to whom short-term movement doesn’t matter.

What Should Individuals Do?

Risk profile changes with change in time as a change in job or assets or anything which impact the risk capacity. Knowing your risk profile is very important to understand what kind of investor you are and in what kind of stocks or funds, you should invest.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.

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