Treasure your risk profile!
Risk profile - What is it and why should I care?
How much risk are you willing and able to take? These thoughts are important and you need a certain understanding of your very own risk profile (= risk tolerance results). But how exactly do you determine that?
1. Your risk capacity
The risk capacity indicates how much risk you are able to take, hence this comprises income, debt and net worth. It is easy to measure by taking into consideration your debt and your net worth. This defines your maximum risk capacity. The risk capacity is also influenced by factors such as age - the younger you are, the more risk you can take. If you retire in 5 years, you can not take losses anymore as easily as if your were younger.
2. Your risk aversion
Risk aversion refers to the emotional part in risk taking. This is not easy to assess as this measures which risk you are willing to take and which fluctuations on the market you are able to tolerate. Normally the risk aversion is categorized into 3-5 risk profiles. In a three category system there is an aggressive, moderate and conservative investor. The five category system features an aggressive, dynamic, neutral moderate and conservative investor. In order to determine which type of investor you are, you normally are quizzed on:
“If the stock market would fall with 20% in a year, what would you do?
"Would she, if the stock market had fallen 20 percent in the course of a year:
a) Do nothing
b) Wait a few months to make a decision
c) Sell shares immediately. "
An aggressive investor would choose a), a moderate investor response b) and a conservative investor response c). This question and additional questions form a picture of how much risk you can take and which percentage of risky assets you can handle.
3. Your risk profile
Based on the results of the risk capacity and risk aversion the risk profile is calculated. Linking both is important: let’s assume you are an aggressive investor but you only have 5 years to retirement. In this case you would rather be a neutral or even moderate investor as you cannot take losses so well anymore. You are anymore able to compensate for the losses - time is a limiting factor
Online questionnaires such as easyfolio can be used to determine the risk profile (https://easyfolio.de/produktangebot/welcher-investment- type-bin-ich/)
4. Your investment strategy
The risk profile determines the investment profile, i. how the portfolio is divided into asset classes. Often, tools like easyfolio provide you with an asset allocation. This allocation enables you to define how many shares you should have in your portfolio. For example, an aggressive investor has between 80-100% shares as part of her asset allocation.
To sum it up, the risk profile enables you to assess yourself as an investor. It helps you stay within the confines of your own risk appetite.
Written by Clara Creitz
Finelles Founder. Coach and Consultant (UBS, Towers Watson).