Risk profiling: Setting boundaries right
Risk profiling is a must not only from the point of view of obtaining the right investment advice, but also a legal requirement according to SEBI Investment Adviser Regulations 2013.
Classical Definition of Boundary - a line which marks the limits of an area, a dividing line.
In school, this word was often heard during the geography class, and more often during the cricket matches. Each walk of life has its own rules. In geography crossing boundaries means you are entering a new area or region, whereas in cricket means it is a four or a six. Personal finance is no exception. It has its own rules, and more often it has boundaries too, just that one needs to be made aware of them.
In the world of investments, we all know the most preached saying ‘Sell High & Buy Low’. It is another matter altogether that most time the opposite is evident ‘Sell Low in panic & Buy High in greed’. The reason of investment failures is pretty simple and deeply embedded in behavior of most individuals, known as crowd comfort - an investor tries to seek comfort in what most people around him do. Therefore most people are ultra confident in a rising market and ultra fearful in a falling market not because it is rising or falling. They become more confident because most people are reacting to the market movements in a particular direction and therefore one feels the risk is lower in acting with the crowd. In that process, somewhere the boundaries are crossed. Though each investor has a unique DNA, they end up behaving in same manner or end up following a particular trend. That is the point where most disasters happen. Most investors are not comfortable walking in unchartered territory without any support and at the same time they are following a trend that is not there in their DNA. To avoid such disasters, it pays to know the boundaries.
Risk profiling helps us determine the boundary. Over a period of time, the process of using risk profile to define boundaries for investors has evolved. For me, it all began with a very naïve understanding of this process. In the initial years, it was just a process and I could not apply this process to set boundaries in real life for real investors.
However, there was no point in going with thumb rules like 100 minus your age should be your equity allocation. Let us understand this with an example. We are told that a young guy, aged 30 years, can take more risk just because he has more time in hand compared to a 60 year old gentleman who cannot take more risk because of his age. However, in real life, it could be the other way round. Due to sheer experience over several years, a 60 year old gentleman may have developed the tendency to take calculated risks whereas due to limited experience, a 30 year old man may be conservative. So to put it straight there is no scope for generalizations.
It pays to conduct a risk profile test designed by a team of psychologists and tested on lakhs of individuals. It can bring out the inherent risk profile of the investor. The investment adviser, with sheer practice, can improve the test results. By engaging the client in a meaningful conversation, the investment adviser can understand the story behind each response and then the real financial DNA of the investor surfaces.
If you want to really set the boundaries right, you should not rush at this stage and let the investment advisor take you through the entire process. If any one – the investment adviser or the client – simply do the risk profiling test for the sake of doing it, then there is a risk of setting boundaries which turn out to be most unsuitable to the investor.
If an investment adviser recommends an asset allocation based on the real risk profile of the investor, then it is highly likely that the investor will stay put with his investments when markets turn volatile. If the risk profile is not paid heed to, then there is a risk of clients overstepping their recommended course of action and there is little the investment adviser can do to help the client.
There are instances, in which individuals question why they cannot get into a new investment or want to explore unchartered territories after spending some time in the recommended asset allocation. In such cases, the investment adviser and the client should sit together and again go through the process of risk profile. Revisiting the risk profiling questions and the responses provided by the client himself, often resolves the questions where the investor respects his own boundary simply because that is what he has responded to.
Risk profiling is a must not only from the point of view of obtaining the right investment advice, but also a legal requirement according to SEBI Investment Adviser Regulations 2013. Respect boundaries and see a sustainable wealth creation in years to come , if the word sustainable is well understood , you know how important setting boundaries could be even before you start your security or fund selection.
Happy Investing
Source:Moneycontrol.com
Risk profiling is a must not only from the point of view of obtaining the right investment advice, but also a legal requirement according to SEBI Investment Adviser Regulations 2013.
Classical Definition of Boundary - a line which marks the limits of an area, a dividing line.
In school, this word was often heard during the geography class, and more often during the cricket matches. Each walk of life has its own rules. In geography crossing boundaries means you are entering a new area or region, whereas in cricket means it is a four or a six. Personal finance is no exception. It has its own rules, and more often it has boundaries too, just that one needs to be made aware of them.
In the world of investments, we all know the most preached saying ‘Sell High & Buy Low’. It is another matter altogether that most time the opposite is evident ‘Sell Low in panic & Buy High in greed’. The reason of investment failures is pretty simple and deeply embedded in behavior of most individuals, known as crowd comfort - an investor tries to seek comfort in what most people around him do. Therefore most people are ultra confident in a rising market and ultra fearful in a falling market not because it is rising or falling. They become more confident because most people are reacting to the market movements in a particular direction and therefore one feels the risk is lower in acting with the crowd. In that process, somewhere the boundaries are crossed. Though each investor has a unique DNA, they end up behaving in same manner or end up following a particular trend. That is the point where most disasters happen. Most investors are not comfortable walking in unchartered territory without any support and at the same time they are following a trend that is not there in their DNA. To avoid such disasters, it pays to know the boundaries.
Risk profiling helps us determine the boundary. Over a period of time, the process of using risk profile to define boundaries for investors has evolved. For me, it all began with a very naïve understanding of this process. In the initial years, it was just a process and I could not apply this process to set boundaries in real life for real investors.
However, there was no point in going with thumb rules like 100 minus your age should be your equity allocation. Let us understand this with an example. We are told that a young guy, aged 30 years, can take more risk just because he has more time in hand compared to a 60 year old gentleman who cannot take more risk because of his age. However, in real life, it could be the other way round. Due to sheer experience over several years, a 60 year old gentleman may have developed the tendency to take calculated risks whereas due to limited experience, a 30 year old man may be conservative. So to put it straight there is no scope for generalizations.
It pays to conduct a risk profile test designed by a team of psychologists and tested on lakhs of individuals. It can bring out the inherent risk profile of the investor. The investment adviser, with sheer practice, can improve the test results. By engaging the client in a meaningful conversation, the investment adviser can understand the story behind each response and then the real financial DNA of the investor surfaces.
If you want to really set the boundaries right, you should not rush at this stage and let the investment advisor take you through the entire process. If any one – the investment adviser or the client – simply do the risk profiling test for the sake of doing it, then there is a risk of setting boundaries which turn out to be most unsuitable to the investor.
If an investment adviser recommends an asset allocation based on the real risk profile of the investor, then it is highly likely that the investor will stay put with his investments when markets turn volatile. If the risk profile is not paid heed to, then there is a risk of clients overstepping their recommended course of action and there is little the investment adviser can do to help the client.
There are instances, in which individuals question why they cannot get into a new investment or want to explore unchartered territories after spending some time in the recommended asset allocation. In such cases, the investment adviser and the client should sit together and again go through the process of risk profile. Revisiting the risk profiling questions and the responses provided by the client himself, often resolves the questions where the investor respects his own boundary simply because that is what he has responded to.
Risk profiling is a must not only from the point of view of obtaining the right investment advice, but also a legal requirement according to SEBI Investment Adviser Regulations 2013. Respect boundaries and see a sustainable wealth creation in years to come , if the word sustainable is well understood , you know how important setting boundaries could be even before you start your security or fund selection.
Happy Investing
Source:Moneycontrol.com
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