Risk appetite means your readiness to take the risk. Risk profiling is an approach to understand the risk appetite of investors – an essential pre-requisite to advise investors on their investments.
Factors that determine the risk taking ability
Investments of every type carry some element of risk. However, the ability to take risks varies from investor to investor. There are several factors that determine the risk-taking ability of a person. These factors include the investor’s age, his income level, the number of people financially dependent on the investor, number of earning members in the family etc. Risk appetite increases as the number of earning members increase in a family. And risk appetite decreases as the number of dependent members increase in a family.
Risk Profiling and Financial Planning per se
Portfolio construct for every investor needs to be mapped to their risk tolerance level. At times it is seen that the goals for an investor are aggressive while he does not have the required risk appetite. In such situations it is important to temper down the financial goals so that risks are lowered. If a person wants to multiply his savings and can afford to see capital depletions for a few years, then he is willing to take risk.
Finding the risk taking ability
To find out the risk taking ability of an investor, industry players depend on various types of tests, a mix of subjective as well as objective questions. There are a number of softwares designed to determine the risk taking capability of an investor on the basis of situational reaction. Through these tools financial planners decide whether to suggest an aggressive or conservative portfolio.
As a prospective investor who wants to put in place a financial plan, he should be ready with some basic information about him and his family. These include age of each of the family member, annual income, the number of earning member and dependents, the bank account details, investments already made, some idea about monthly expenses etc. The rest could be left to the financial planner.