Risk Profiling – Why Is It Important?

Assessing our client’s tolerance to risk is a fundamental part of what we do as financial advisers. But why is it so important?

During times of strong investment markets, where every investment grows in value, it’s easy to ignore the importance of risk profiling. However, during more tumultuous times, investing in line with your risk tolerance can provide a level of comfort.

Consider two different people:

• An 18 year old starting an apprenticeship; and
• A 70 year old, retired and downsizing their home

They both may need a super fund, and they both may have limited experience with investing. If they both opened super funds with the same provider and took no interest in the investments, therefore receiving the ‘default’ option, they would both likely end up with their super funds invested exactly the same way. Is this appropriate?

Some may argue that it is. We would argue that it isn’t. Each individual’s attitude to risk is different and their investment experience is different. Their investment timeframes are different, and their investment experience is different. Investing is not a ‘one size fits all’.

The older investor will potentially have less time in the market, and perhaps no ongoing pay cheque to ensure income if there is a deep and lasting market correction. It is safe to assume that this investor would take a more cautious approach.

On the other hand, the younger investor has many more years to accumulate super and therefore can afford to take more risk. This may lead them to invest more aggressively and have more of their funds in growth assets rather than invested defensively.

There are many reasons for this argument, one such being that a Balanced profile may not be as middle of the road as one would assume. Many fund managers change their investment preferences according to market movement and this may mean that at certain points, the Balanced profile may be more aggressive in nature but still labelled Balanced and vice versa. It is important to look further into the individual managed funds to discover their true risk profile.

There are a number of levels of risk tolerance that are mainstream in the financial planning world: Typical categories include – Conservative, Moderate, Balanced, Growth, Aggressive and Very Aggressive. Each one usually has a preferred split of what percentage of assets should be placed into defensive investments (such as cash and fixed interest) and into growth assets (property and share holdings).

Your risk tolerance is based on your individual circumstances, and will differ from others. For us, we typically start by asking you to complete a Risk Profile Questionnaire. This assists us to determine an appropriate asset allocation for you. Its not the be all and end all though; an in-depth discussion is also required to ensure both adviser and client are on the same page.

A Risk Profile Questionnaire may look something like this:

https://www.surveymonkey.com/r/ZL3G3HV

Feel free to have a go and let us know how you went. A warning though, we have just pulled this quiz together – it is not an actual Risk Profile Questionnaire. Please don’t make any investment decisions based on the results of this. It is general in nature, and is aimed at prompting further discussion.

So how did you go? What were your results?

You are a ‘conservative’ investor with some understanding of investment market behaviour who seeks a portfolio comprising mainly of interest bearing assets.  You give a high priority to the preservation of capital and are not willing to take on any or only very little risk in order to achieve returns.
Perhaps an asset allocation that is suitable for you is 15% exposure to growth assets (Shares and Property) and 85% to defensive assets (Cash and Fixed Interest).

You are a ‘moderate’ investor with some understanding of investment market behaviour who primarily seeks income with some potential for capital growth. You seek a low level of investment value volatility and are only willing to take on a small amount of risk in order to achieve returns.
Perhaps an asset allocation that is suitable for you is 30% exposure to growth assets (Shares and Property) and 70% to defensive assets (Cash and Fixed Interest).

You are a ‘balanced’ investor with some understanding of investment market behaviour who seeks both income and capital growth.  You desire a modest level of capital stability but are willing to accept moderate investment value volatility and risk in order to achieve returns.
Perhaps an asset allocation that is suitable for you is 50% exposure to growth assets (Shares and Property) and 50% to defensive assets (Cash and Fixed Interest).

You are a ‘growth’ investor with some understanding of investment market behaviour who seeks some capital stability, but the primary concern is a higher return.  You are willing to accept higher levels of investment value volatility and risk in order to achieve returns.
Perhaps an asset allocation that is suitable for you is 70% exposure to growth assets (Shares and Property) and 30% to defensive assets (Cash and Fixed Interest). 

You are an ‘aggressive’ investor with some understanding of investment market behaviour who seeks growth over capital stability.  You are willing to accept high levels of investment value volatility and risk in order to achieve returns.
Perhaps an asset allocation that is suitable for you is 85% exposure to growth assets (Shares and Property) and 15% to defensive assets (Cash and Fixed Interest) based on the Morningstar recommendations. 

You are a ‘very aggressive’ investor with some understanding of investment market behaviour who seeks maximum growth with no concern for capital stability.  You are willing to accept very high levels of investment value volatility and risk in order to achieve returns.
Perhaps an asset allocation that is suitable for you comprises 100% Growth assets (shares and property).

Entertaining as a quiz may be, your risk profile is something that changes regularly, your liabilities, risk attitude and age all affect your score. Changes in circumstance are likely to alter your risk tolerance.

Our advisers are happy to take you through and extensive risk profiling process. Contact us today!