Check your Risk Profile

My Friend Raj is an engineer who is good in saving, He is saving money for past many years, however all his money is going in fixed Deposits. One day while discussing generally, he told me this and I asked him why is he keeping everything in FDs, he replied he is interested to invest in higher yielding comparatively risky investment avenues but he don’t know how much risk he can take and what is suitable option based on his own risk profile that’s why he ended up in FDs.

Well this is a very common thing I heard from many other investors. So the question is how to gauge your risk and then how to match the investment options with the risk profile. So let us simplify the Risk profiling.

1.      Segregate Goals             

Firstly we need to segregate each and every goal based on time and amount required. There could be different goals like next vacation tour in holidays, buying a car or, retirement planning etc.

2.      Setting Time frame        

After segregating the goals we need to setup a time frame for these goals, which will help them decide how much investment risk they can take for better returns. For example vacation holidays could be of short term like next summer season, buying a car may be a target of three years and retirement planning is required for the age of 60. Each goal has certain time line to achieve them.

3.      Choosing the Right Investment option  

Once goals are defined and time frame is fixed. The investment can be made based on the time horizon and fund requirements. Setting a time frame for goals will help to decide how much investment risk can be taken for better returns.

Here we need to understand that some of the investments may give high returns but the returns may be volatile over the short term. Such investments require a sufficiently long investment time frame in which the volatility will smoothen out. On the other hand very safe investment options for long term may not be able to match the return potential from the other investment options.

Sometimes we may be tempted to assign high return investments for their short- term goals if they have fallen behind in terms of the goal amount. But the risk in doing that is we may find that the value of the investments has dropped when the money is actually needed.

While selecting investments based on the time horizon of their goals, we should also remember that a longer investment horizon alone does not make a fundamentally bad investment less risky. We need to select only sound investment options/instruments after evaluating their strengths and features.

By aligning their investments to the goal horizon & time frame we can ensure that the level of risk is appropriate without being too high. This way we can put our savings at risk to earn good returns without putting our financial goals at risk from inadequate funds.

We also need to understand that every person has their own financial goals and risk appetite. While doing risk profiling we need to understand the same before selecting the investment options.