Are you investing as per your Risk Profile?
Dec 17, 2013

Author: PersonalFN Content & Research Team

Have you ever felt that return on the mutual fund schemes you have invested in have earned you less than the other funds in the same category? Or, have encountered that sunken feeling that you have been ill-advised by your financial planner / investment advisor and then you pondered upon, that your stock broker would have managed your money in a better way?

If we go by our experience in dealing with clients, the answer to above question would most probably be YES!

And we don’t even blame our clients for thinking this way; rather we try to educate our clients as to why these things happen.

Let’s understand this with the help of three mutual fund schemes maintaining a large cap bias.
 

Report Card
Large Cap Mutual Fund Schemes
SCHEME NAME INCEPTION DATE 6 months 1 year 3 years 5 years Std. Dev. Risk
Franklin India Bluechip Fund 3-Dec-93 4.78% 2.79% 2.15% 18.45% 4.61 Low
SBI BlueChip Fund 17-Feb-06 6.71% 5.68% 3.85% 17.68% 4.83 Average
ICICI Pru Target Returns Fund 2-Jun-09 11.65% 7.62% 3.01% NA 5.42 High
Source: ACE MF, Data as on 16 December 2013
 

If you compare the returns of these 3 schemes, which one of these you would have liked recommended to you in the last 1 year? Well, the obvious answer to this would be ICICI Pru Target Returns Fund, as it has given the highest return in last 1 year.

At PersonalFN we are of the view that it isn’t a bad fund. But it is imperative to recognise the fact that it commands a high risk in the large cap fund category. So, if you as an investor have a high risk profile, only then you should be holding the said mutual fund scheme in your portfolio. Remember your investments in mutual fund schemes should always be in line with your risk profile and its suitability for your financial goal; because every scheme carries some investment risk.

In context to the above table it means that if your risk profile is conservative, then you should have invested in Franklin India Bluechip Fund, while if your risk profile is moderate then you should have invested in SBI BlueChip Fund; because all these 3 schemes have different level of risk involved. And therefore, when you visit your financial planner / investor advisor for an advice on investments, it is vital that he considers risk involved in the respective investment product and weighs that against your risk appetite, so as to not ill-advise you by merely going by the returns clocked.

How to measure your Risk Profile?

You see, risk Profile determines your risk taking capacity and your willingness to take risk. It is measured on the basis of various factors such as: (See our Video: Assessing your Risk Appetite this video will help you to understand how you should go about assessing your risk appetite)
 

  1. Age

    Your age plays a vital role in determining your risk profile. At a younger age your risk taking capacity is high as you have long term horizon for your financial goals but as your age progresses your risk taking capacity decreases. This is primarily because your time horizon decreases as your age increases and you can’t tolerate higher volatility in your investment portfolio.
     
  2. Knowledge about financial products

    Your knowledge about financial markets and financial products also determines your willingness to take risk. Greater your knowledge about financial products, greater will be your willingness to take risk. (See our Video: Introduction to various asset classes - Equity, Debt, Gold to know the features and risk involved in asset classes such as Equity, Debt and Gold)

     
  3. Investible Surplus

    If you have more than 50% of your monthly income as surplus amount to invest, then you would have higher risk taking capacity than the person who has just 10% investible surplus. It means more surplus you have every month to invest, higher will be your risk taking capability.
     
  4. Time Horizon

    If you have time horizon of more than 10 years for your financial goals, then you can afford to take higher risk than a person who has just 1-3 years for his financial goals. Over the long-term you can tilt your portfolio towards risky asset classes (such as equity and real estate) as you have enough time to sustain the short term volatility of high risk investments. So your risk taking capacity increases with longer time horizon. (See our Video: Time Value of Money & When to Start Investing to know the benefits of starting investment early)
     
  5. Investment Objective

    Your investment objective also determines your willingness to take risk. If your investment objective is safety of investment than your willingness to take risk is low while if your investment objective is capital growth than your willingness to take risk is high.

    It is noteworthy that the above mentioned points will measure your risk profile from conservative to aggressive among host of other things. But the final investment decision will also depend upon suitability of your investments towards your financial goal.
     
Suitability of Investment…

Suppose you have a financial goal which is just 1 year away and you are accumulating amount for this goal. Now, no matter how much confidence you have in equity market going up in next 1 year, equity schemes will not be a suitable investment for this goal. This is because of the fact that equity carries high investment risk and 1 year is a very short time to recover from the volatility of equity markets.

Likewise in case of a retired individual who has accumulated a corpus for his post retirement period and may not be generating any fresh income, a majority part of his investment portfolio should ideally be parked in debt / fixed income instruments. This is because his risk taking capability has decreased significantly because of dependency on savings for the rest of his life. (Also Read: Case 4: Planning for your Golden Years to know how you can also plan for your retirement)

Conclusion:

You see, never get carried away with the lucrative returns you might see on some investments, because every investment has some amount of risk involved in it. You should first consider your risk appetite and then the suitability of investment for your financial goal(s), and then decide whether to invest in that financial product or not. Similarly when evaluating your current investment portfolio, don’t judge it only on the basis of the return you have got, but also look at the risk you have been exposed to.

Any good financial planner will always look at your risk appetite and suitability of investment for your financial goals and then recommend you financial products based on your requirement. These might not be the highest return generating financial products, but will ensure that you are not taking too much financial risk but are still able to achieve your financial goals. In the end what matters is smile on the faces of your loved ones when you achieve their financial goals and not the fancy financial products which you could have invested in.


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