To a non-expert, financial terms can come across as complex and difficult to understand. Money, however, is something everyone deals with, and understanding how to make the best of it is of utmost importance. Citi aims to simplify investing so that anyone can get started. The demystifying wealth series breaks down investment concepts and arms readers with the right information to make savvy investment decisions.
In this article, we’ll be discussing investor Profiling.
The Role of Risk in Investment
When it comes to investments, there is usually a trade-off between earning a higher return and having a lower chance of losing money. For instance, investing in government bonds is considered relatively low-risk but the returns are typically not as high as stock market investments. While it is unlikely that you will lose money in government securities, a market linked investment suitable for you can earn you higher returns and the wrong one can lose you money. Risk tolerance refers to an individual’s willingness to take on risk while risk capacity is the ability to take on risk. Risk capacity depends on quantifiable factors such as age, income, current assets, liabilities, etc. Risk tolerance, on the other hand, is more about an emotional tolerance towards risk. Both factors vary by individual and play important roles in determining investor profiles.
What is Investor Profiling?
Also referred to as risk profiling, investor profiling is the practice of classifying investors by their willingness and ability to take on risk, i.e. by their risk tolerance and capacity. On one end of the spectrum, risk-averse individuals have a low tolerance for risk and are willing to forgo potential capital appreciation to avoid losing money. Risk seekers, on the other hand, are willing and able to take on high levels of risk for the possibility of high returns. Investors usually fall somewhere between this spectrum and investor profiling is simply the process of determining where an investor falls on the scale.
So, why is all this important?