At the very heart of Investment Management for a private client lies their risk profiling. Profiling is an umbrella term used to identify the investing traits, investment history and investment needs of the investor. In order to recommend suitable investment options or build efficient long-term investment strategies for them, other factors that need to be taken into account are their long term and short term goals and liquidity requirements with respect to time.
To understand the concept in detail, let us break down Risk Profile into two categories. Necessarily it is a combination of risk capacity and risk aversion of the investor that can be an individual or a company. An investment makes sense only when it falls in between these two categories. The tricky part, however, remains the accurate measurement of this balance. Herein comes the role of an investment guide. Having an investment guide is like having a chauffeur, – the car belongs to the investor but is driven by a professional who assumes the responsibility of steering it in the right direction in order to reach the desired destination. Based on his experience, knowledge of the market and other tools that he is privy to, he can gauge both the risk capacity and risk aversion of the investor. Let us look at a basic model of how that is done.
- Identify and define the goals of the investment
- Create a risk profile using tools like questionnaires, earlier investment profiles
- Analyse and score the data received
- Analyse market trends and allocate investments
- Get approval and implement an investment strategy
The risk capacity of an investor depends on many factors. Some of these are:
- Income stability
- Wealth already accumulated
- Number of dependents
- Individual and family goals
- Investment horizon
Risk aversion however depends on some additional factors as well. These include previous investment results, new immediate needs, short term investment needs etc.
An in-depth understanding of these aspects along with the investor’s comfort with risk-taking is what differentiates a good investment guide from an average one.
To further understand the difference that an investment guide can make, let us look at an example. Let us assume that two investors- Raj and Rahul have equal current financial status, equal accumulated wealth and both are still earning. They both are looking to invest their surplus income in the long term. Raj is comfortable with putting half his money in equity investment and half in debt investment for maintaining a balanced risk portfolio. Whereas Rahul is unsure of risking even a small amount in equity investment because the daily fluctuations intimidate him. He decides to put all his money in debt investments like FDs and other non-market related funds. In this scenario, an investment guide should understand and address these apprehensions, educate both investors about their options and accordingly suggest further course of action. Clearly, Raj has more of a growth risk profile, whereas Rahul has a secure kind of risk profile and their investment strategies, therefore, will differ.
To calibrate investors on the scale between secure and growth, the investment guide further categorises them into conservative, moderate and aggressive. It is also their job to explain to the investor that returns are directly proportional to the risk one is willing to take. He should also be able to explain in detail his various options ranging from large-cap funds, mid and small-cap funds to secure options like debt funds, tax-free bonds etc.
Hence, right investing starts with choosing the right investment guide or consultant. Choose Wisely!