Is your investment portfolio in tune with your risk profile?
December 20, 2019 | 14033 Views
‘Risk’ in equity investing implies the possibility of incurring losses or earning returns that are lower than the market returns. The level of risk can vary from ‘nil’ or no risk, to ‘capital loss’ or complete erosion in capital invested. And there is a wide range between zero-risk to complete capital erosion. All of us have our own unique level of risk capacity and tolerance. ‘Risk capacity’ implies your ability to stomach risk in terms of your demographic profile (your age, number of dependants, income, etc.) while ‘risk tolerance’ implies your affinity towards risk or your ‘like’ or ‘dislike’ of risk. A combination of the two parameters provides your investment risk profile. Based on this, investors are broadly categorized as ‘High risk takers’, ‘Medium risk takers’ and ‘Low risk takers’. There could be a number of levels between these three broad categories.
Each stock carries a particular level of risk. For instance, a midcap stock would carry a higher risk than a large cap stock, or a small cap stock would carry a higher risk than a midcap stock or a large cap stock. Stock selection to build an investment portfolio should be in sync with the investor’s risk profile. In other words, the average risk inherent in the portfolio should match the investor’s risk-taking capacity. Here is an example of why this is to important. Let’s say you are comfortable with a little risk which makes you a medium risk taker. Now if your investment portfolio loses 50% over the next week, you would be very worried, but a high risk taker would be okay with this drop in his investment portfolio.
At StockAxis, we believe that our best tool for gauging an investor’s risk profile (apart from a system-driven risk profiling), is to listen to our clients during the pre-subscription period. The process begins with the client providing details of his existing investment portfolio for our review. The open lines of communication with our clients during this process gives us a fair idea of their risk capacity and tolerance, and hence, their investment preference. This process helps us to suggest a suitable service that would deliver returns based on the client’s expectations and risk profile. And yes, we carry out adjustments based on the client’s specific needs.
As Investment Advisers, we consider it an obligation to educate our clients about investing, which includes optimal equity allocation based on their long-term growth objectives and their current financial situation. In many cases, that means recommending a significant percentage of the allocation to stocks, which may push a client to their boundaries for the amount of equity-risk they’re comfortable having. This is unique to StockAxis; other investment advisers tend to recommend overly conservative investments to risk-averse clients, since those investments aren’t likely to inflict significant losses during periods of decline in the markets. This strategy may make the client feel good, but won’t ultimately produce the growth needed to help the client actually realize their long-term goals. In our view, it is riskier in this case NOT to recommend slightly riskier investments, which have good chances of yielding substantial gains over time.
The opposite can also be true. There may be some clients whose positive experiences in the markets lead to overconfidence, and/or aspirations for extravagance, which may lead them to speculative investments or overexposure to equities. These allocation decisions may make them take very high resulting in potentially large losses, which would also compromise their ability to meet a long-term objective.
There is a delicate balance to be found with each client, and again our goal is to listen to our client to help them achieve their specific investment goals keeping their risk profile and investment objectives in mind.
Finding the right balance and understanding your particular financial situation takes times as you look at your long-term goals, your investment time horizon, risk tolerance and other factors. This can be a difficult process to navigate on your own. To help you get a head start, we advise you to answer a questionnaire to find out your risk tolerance level and the optimum amount you should allocate towards equities. Get your free Risk Report copy today by clicking on the link below.