You may not have given much thought to your risk profile, but perhaps it’s time you did. After all, it can have a huge impact on the financial decisions you make – or don’t make – now and in the future, which can in turn influence your wealth position as you head towards retirement.
Essentially, risk is another word for fear: when you are concerned about the risk involved in a certain situation, what this really means is that you’re fearful of the potential negative outcome.
In financial terms, your risk profile is a summary of your attitude towards various elements to do with finances, money management, debt and wealth.
Those with a high appetite for risk are more likely to take a chance and make bold financial decisions, whereas those who are risk averse are less likely to jump into big financial decisions without crossing every ‘t’ and dotting every ‘i’.
Neither risk profile is necessarily right or wrong, but your personal risk profile will have a significant impact on the way that you manage money and create wealth.
Venn Williams, co-author of ‘Rocket Your Way to Financial Independence – Demystifying the Wealth Creation Process’, believes it’s important to work out your risk profile so you can “find out which types of investments would still allow you to sleep at night”.
“While it’s important for everyone to understand their risk profile, it’s doubly important for people in relationships to understand their partner’s risk profile,” he explains.
“When two people with potentially different beliefs, experiences and risk profiles come together, they need to somehow manage their financial situation together… [and] when a bad financial decision enters a marriage, beware. It would seem that a marriage can survive many setbacks, but if one partner loses any money, he or she is never allowed to forget it.”
To work out your own risk profile, Williams advises that you ask yourself the following questions:
- Am I more concerned to preserve my capital/savings, rather than outpace inflation?
- Am I willing to accept fluctuating values for long-term investments?
- Would I prefer a combination of dividends and income, or just focus on growth through capital appreciation?
- Am I willing to accept above-average risk to generate above-average returns?
- Am I investing for a specific reason, such as a home deposit or holiday?
“The more you know about your attitude to risk, the better suited your investment portfolio will be for you,” Williams says.
If your risk profile reveals that you’re a defensive investor, for instance, this means you’ll be most suited to investing in cash and fixed interest investments, “which are the asset classes with the lowest volatility”.
“The more dynamic an investor is, the more exposure you’ll have to growth assets like property and shares,” Williams adds.
“The main point of working out your risk profile is so that you can invest in asset classes that you’re comfortable with.”
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