Understanding the impact of a risk profile
One of the first steps when establishing a professional relationship with your financial adviser involves a risk assessment. This is important because your risk attitude tells your adviser how you feel about investing and your willingness to take on investment risk.
This means the advice you receive is tailored not only to your financial needs, but also your capacity for risk so you are more likely to stick to the financial plan that is drawn up for you. While a financial plan can look great on paper, the real test is whether you are able to ignore emotional triggers such as media headlines and stay focused on your long-term investment strategy.
Your risk profile is based on:
- Your comfort regarding risk, which is a product of your psychological traits.
- Your personal investment preferences.
Speaking in an interview, Discovery Invest Head of Research and Development, Craig Sher, says the effectiveness of the risk-profile assessment depends on the questionnaire that an adviser chooses to use. Questionnaires that include only emotional-type questions, such as whether you enjoy bungee jumping - to assess if you are an aggressive investor - are irrelevant to creating the right investment strategy for you, he says. Instead Sher says that questions about your time horizon are more relevant, for example, if you are able to invest for a lengthy period, you can afford to take on more risk to reach your investment goals than if you have a short time horizon.
Taking all the above factors into account helps both you and your adviser to put together a "risk portrait" before making any investment choices.
Any suggested strategy is then contextualised, because you will know how much risk you should take, as well as how you are most likely to feel about the strategy during the ups and downs of the investment. Although you might feel anxious during times of market volatility, you will at least be aware that this reaction is due to your risk profile and you should rather focus on a strategy designed to achieve your longer-term end goal.
Discovery financial advisers make use of a carefully designed questionnaire. It elicits responses that measure both your risk capacity and risk attitude as an investor. The capacity to accept risk tells your adviser how much investment risk you should objectively take to meet your desired outcomes. This is based on your financial circumstances and your investment goals.
Types of risk profiles
There are five basic risk profiles that an adviser can use, when looking at how much risk you can tolerate.
| Risk portrait | Investment requirements | Investment strategy | Investment timeline |
| Conservative | Stable growth and/or a high level of income. | Conservative strategy required. | Three years or less. |
| Moderately conservative | Fairly stable growth and/or a moderate level of income. | Not comfortable taking risks but requires less conservatism to generate returns. | Three years or more. |
| Moderate | No income required. Client can tolerate fluctuations in the anticipation of higher returns in the long-term. | Moderate investment strategy required. | Five years or more. |
| Moderately aggressive | No income required. Client can tolerate a fair level of fluctuation in the investment based on possible higher returns. | A medium level of risk tolerance must be balanced against a longer time line over which to recoup any paper losses incurred over the timeline of the investment. | Five to ten years. |
| Aggressive | Substantial fluctuations can be tolerated in anticipation of the highest possible return over 10 years or more. | Aggressive strategy can be used. Although volatility will be higher in the short-term, this is off-set by higher long-term returns. | Ten years or more. |
Disclaimer
This article is meant only as information and should not be taken as financial advice. For tailored financial advice, please contact your financial adviser.
Discovery Life Investment Services Pty (Ltd): Registration number 2007/005969/07, branded as Discovery Invest, is an authorised financial services provider.