BackDYK:Difference between risk profiling and risk appetite
Risk profiling involves a study of three broad aspects of a client.
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The next time you go to your financial adviser, don’t be surprised if she gives you a form to fill, if you haven’t filled up this form already. Apart from your basic details, this form will ask you questions such as your past investment habits, financial goals, perhaps also things such as how you are likely to behave when the equity market goes up or down and so on. Reason being most likely she wants to do your risk profiling. What’s the purpose? She wants to calculate your risk appetite. This process is called risk profiling. In January 2013, when the capital markets regulator issued the investment adviser guidelines, it made it mandatory for investment advisers to profile their clients. As per the guidelines, this will be done through a questionnaire that your adviser will give you. Based on your responses, your adviser aims to ascertain how much risk you can take. In other words, your risk appetite. She then goes on to recommend you investment products that are most suitable for you.
What does risk profiling include?
Typically, risk profiling involves a study of three broad aspects of a client. Risk capacity wherein the planner takes a look at the client’s finances, her balance sheet, net worth, income inflows and so on. It shows how much financial risk the client can take. Then comes risk tolerance. This shows how much risk the client is willing to take. This is more of a psychological evaluation and something that the planner must ascertain using her own intuitive skills, observation and understanding of the client’s mindset. Lastly, there is risk required. This means a study of the client’s financial goals and the time horizon—and therefore risk required—required to reach those goals.
Is risk profiling the only thing?
FinaMetrica, an Australia-based applied behavioural finance specialist, has devised a psychometric questionnaire that they claim comes closest to ascertaining an investor’s true risk tolerance. It says that their 25-question test has been taken by about 600,000 investors across 22 countries through some 5,600 advisers. Some Indian financial planners and distributors have also now subscribed to this test, for a fee, that they now mandate their clients to take. Though many distributors such as banks swear by risk profiling and mandate their customers to fill in such questionnaires, other financial planners avoid risk profiling. This set of financial planners believe that people’s responses change in different circumstances. For instance, you may say you are not risk averse and can invest in equities, but may get scared of investing in equities when they fall. Further, a risk-averse investor might be tempted to put more money than she should when equity markets rise continuously. These financial planners study a client’s financial goals and time horizon and suggest suitable products, followed by periodic reviews.
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