What is you investment risk appetite and why is it important?

When Obaid signed up to create an investment account, he was asked several questions related to his profile and background. These include questions on how long he had been investing, whether he had formally studied investing, and if he would be considered a high-net-worth individual. These details, he was told, would help classify him as an investor.

Why is investor classification important? Any financial intermediary – bank, broker, asset manager, or advisor – needs to develop such a profile. It protects the investor by limiting the risk to which they would be exposed. Without a risk profile, the investments an intermediary makes can expose an investor to much higher risk than they may be comfortable with.

Conservative or growth investor

Depending on their risk tolerance, which essentially translates as ‘how much money can an investor afford to lose without being in a crisis?’, an investor is classified on a continuum of conservative to bold.

Conservative investors are typically risk-averse – they would prefer investments which guarantee their capital remains safe. The flip side of this is accepting lower returns to ensure security.

At the other end of the scale are growth investors or bold investors whose goal is to maximize growth and earnings. With a higher risk of losing part or all of their invested capital, they can invest in products with higher returns over relatively shorter periods.

Risk profile

Financial situation: A risk profile takes into account your current financial situation, including how much you earn and how much you owe, and prospects for income growth.

Time horizon: This is essentially how much time you can stay invested without needing to access the funds. It may depend on age or life stage.

Risk tolerance: Your emotional profile will matter in how much uncertainty you can tolerate without needing to act.

Investment goals and experience: Your familiarity with investing, and whether you intend to preserve or grow your capital, are part of your profile.

Why classification matters

Your risk profile is created to match your investments with your financial goals and your tolerance for loss and volatility.

• It becomes the basis for asset allocation in your portfolio mix.
• It helps you avoid investing in products that are too volatile so that there is a protection against panic selling.
• It becomes a decision-enabling tool to help match you with investments that align with your risk and goals.

Finally, a risk profile is not static. It needs to be reviewed at set periods to reassess your risk appetite.