We’re spring cleaning our finances this month. Once your budgeting process is sorted, you need to consider getting profiled in terms of risk. A client’s risk profile is one of the first and most important things we try to understand during the financial planning process.
There are many methods and as many outcomes to risk profiling but the ultimate point of it is the following:
- To try and understand how an investor feels about risk
- To figure out how much risk an investor needs to take on in order to achieve their financial goals. This is a financial calculation that we do for clients.
- To reliably predict how an investor is likely to behave under certain market conditions
A desired outcome of a risk profile is something that looks like this:
This graph depicts the various investor personality types and the negative behaviours they are likely to exhibit while invested in market. DALBAR, a global leader in investor behaviour studies, has found that investors consistently earn much less than market indices would suggest and it has everything to do with their emotions which lead to irrational behaviour.
Once we understand the emotions and the potential negative behaviour, we can then put together an investment portfolio that seeks to manage this, or even eliminate it altogether, by addressing the investor’s financial needs and concerns simultaneously. Once behaviour is managed, there is a higher likelihood of an investor staying invested for longer. Overtime, this increases the investor’s likelihood of reaching their goals.
There are quite a few free tools available online that can help you understand your risk profile, however, you’d do well to consult a professional to talk you through the process and to help you interpret and understand your results.