Profiling Risk Appetite…

Investing is about seeking opportunities and converting these into solid gains, and the ‘quest’ for returns is most successful if the approach is systematic.

Risk profiling is one of the ways to prevent losing out. And this does not include simply completing a 10-question questionnaire - It is about taking the time, to think and formulating answers to the most elementary questions like: ‘What is your current financial situation? What is the risk that you are prepared to take? What is the purpose of your investment? or When do you need the money back?

Academic analysis teaches us that the right distribution between cash, bonds, equity and even real estate, determines almost 70 per cent of your investment result. That is why it is important that this asset allocation fits your situation and maximises your financial advantage.

But your risk profile is only a component of your overall investment profile. You should also take into account your knowledge and experience about investing. For example, if you have never invested in stocks before, you should get expert guidance on the concept of stock markets and stocks, before taking any position. Be advised that emotions can be a dangerous guide. In times of euphoria or depression, emotions lead you to take wrong decisions. Here your level of knowledge and experience are the driving factors.

Step 1: Your current financial situation

Aggressive risk taking is not based on a ‘dare devil attitude,’ but on your financial capacity, which means your monthly income and existing wealth. The higher your capacity, the more risk you can bear. The most important element is your cash buffer. Many investors lose money because they need to sell during difficult times to pay off debts. You can prevent this situation by reviewing your monthly expenses and setting aside at least 6 to 12 times this amount.

Step 2: What risk?

There are two ways to look at risk. Firstly, you have ‘objective risk’ that results from a mathematical and statistical approach. It is expressed in a set of ratios that assesses volatility and compares risk between different investment products. A wealth advisor could probably assist you in understanding this better.

However, you should also take into account another view on risk - the ‘subjective risk’. This element is based on what you perceive - as an investor - to be an unwanted event. Again, your experience and knowledge are the main drivers of subjective risk. Your reactions to a specific market situation will be more controlled and rational, if you are prepared and well informed.

Step 3: Set your goal & determine your horizon

Be it retirement, children’s education or a world trip, you need to set your financial objectives for the future. In this way, you create an investment goal that is clear and measurable. Considering investment positions accordingly is a trade-off between security and capital growth. From a horizon perspective, the longer the time for the maturity of a financial goal, the smaller the risk involved. Investment results are more stable and even in the long term. Consequently, when you are getting closer to your goal, you will move to a more conservative profile.

Step 4: Evaluate and Review

It is important to review your profile and update it at regular intervals. When your monthly income goes up or down, your risk appetite or your goals will get impacted. Re-evaluating the risk you are taking can help you to stay on course in a changing environment. When you don’t feel comfortable with certain financial market evolutions, it is wise to evaluate your current profile without letting your emotions taking the lead.

Frederic de Melker is Head – Priority Banking, Emirates NBD. Opinion expressed here are his own and do not necessarily reflect that of Gulf News.