What is your risk profile and how does it work?

A large part of investment is taking on financial risks. This may seem like a bit much but depending on how you approach investment, you can mitigate your financial risk.

This is why you should perform a risk assessment and profile. It helps to understand your willingness to take risks as well as your ability to lose money or not. Based on this, you will start creating your investment profile and start making your money work for you.

Understanding risk profile

The investment choices that you make should be aligned with your financial risk profile. The risk profile defines how much risk you are willing and able to take and is made up of three main parameters:

  1. Risk required
    This is the level of risk that is needed to get the growth you want.
  2. Risk capacity
    The level to which you are able to take risk without putting your finances under unnecessary strain. This will depend on personal factors such as age, income level, job stability, your investment horizon and how much money you have to invest.
  3. Risk tolerance
    This is based on your capacity to manage and accept risk. You’ll need to ensure that you have the emotional strength to deal with the variability and fluctuations in investment returns. This will also depend on your financial stability and access to extra cash for investment.

Understanding your risk profile is important for medium- to long-term investments. For shorter investment terms you should avoid investments with fluctuating returns that can eat away at your initial investment amount and focus on investments with better returns on investment through compound interest.

Your investment goals might require more risk than you are willing to accept. This means to get more growth you may have to make a riskier investment − and that you’ll need to ensure that your investment approach makes space for both your investment needs and your risk profile.

How to get started

To gauge your risk profile, you need to understand what kind of risk-taker you are. There are five types of risk takers:

  1. Conservative risk-taker - this is for investors that aren’t very eager to take on financial risk and have a tendency for very low risk-taking.
  2. Moderately conservative risk-taker - investors that are open to a modest amount of risk, but only if there is guaranteed income.
  3. Moderate risk-taker - this is for investors that are open to risk as necessary without stretching the boundaries.
  4. Moderately aggressive risk-taker - these investors are open to risk and won’t be discouraged by poor investments, but the risk won’t be taken lightly and will go hand in hand with extensive planning and research.
  5. Aggressive risk-taker - these are risk-takers that don’t mind the volatility of the market and are open to taking risk even if they’re not sure of a return on investment. These are very high risk-takers.

To find out what kind of risk-taker you are, you’ll need to complete a questionnaire that will include questions like the following. The more likely you are to agree with the question posed, the higher your openness to risk for financial gain.

You can use the below as a guide:

QuestionStrongly agreeAgreeNeither agree nor disagreeStrongly disagreeDisagree
I’m open to the ups and downs of investments.
I’m stressed when it comes to making important financial decisions.
It’s important to take on financial risk.
I’m more open to bigger investment risk than other people.
I’ll accept investment risk even after suffering losses from previous investments.
I’m open to short-term loss for long-term gain.
This information is for general information purposes only and is not legal advice.