Risk Profiling - Understand Your Attitude To Risk

See what makes a cautious, medium or adventurous investor, and what investment risk you may accept.

Picture - Courtesy of aspinplan.com


Balancing risk and reward
- Sunday Times 24 January 2010

When investing money, consider your need and ability to take risk

Higher returns equals higher risk. It’s a basic fact of investing, yet working out just how much of a gamble you are willing to take with your cash is far harder to pin down.

The other side of the coin is when investors get so caught up chasing high returns that they ignore the risk element.

So it’s worth trying to understand what your personal risk profile is before investing your money.

If you have engaged an adviser, he should try to assess your risk profile before recommending a suitable investment portfolio which gives the returns you need with a level of the volatility that you are able to withstand, said chief executive Christopher Tan of wealth management firm Providend.

‘Doing this well will ensure that clients will stay invested and not get out of the market unnecessarily, which is the main cause of investment failure,’ he added.

‘In a nutshell, it is to make the investment journey comfortable and yet achieving goals.’

But assessing a risk profile is not that simple as emotions can get in the way.

Take Ms Nancy Boon, 50, who parked her money in an ‘aggressive’ portfolio comprising 90 per cent equities and 10 per cent bonds.

It was only when her portfolio headed south during the downturn that she realised that she was unable to stomach the volatility.

Ms Boon’s zest to achieve higher returns had clouded her judgment of her risk appetite and led her into an ‘aggressive’ portfolio.

The willingness to take risk is just one facet in managing risk. It is even more important to ask yourself this: Do you need to? Are you able to?

Here are three factors you should consider before investing:

1 Willingness to take risk

Simply put, the willingness to take risk – called risk tolerance – reflects your attitude towards risk. It is the amount of risk you are comfortable taking, or the degree of uncertainty you can handle.

For example, if you can sleep soundly even when your investments are experiencing dramatic swings in value, you are considered risk-tolerant. But if they keep you up at night, you are risk-averse.

Risk tolerance often varies with age, income and financial goals.

Financial institutions in Singapore typically measure risk tolerance using a profiling questionnaire.

Risk tolerance levels are usually classified as aggressive, balanced or conservative. Each level helps determine the percentage of equities and bonds to hold. Equities are deemed riskier than bonds.

Mr V. Arivazhagan, DBS Bank’s managing director of consumer banking, said risk profiling is part of a fact-find process the bank conducts with customers so it can better understand their needs and assess product suitability.

‘It enables us to determine a customer’s risk appetite and preference which is one criterion in the overall process of recommending suitable products for customers’ consideration and assessing pro-duct suitability,’ he said.

However, Mr Leong Sze Hian, president of the Society of Financial Service Professionals, believes the traditional profiling questionnaire is unable to adequately measure all aspects of risk.

2 How much risk you can take

Besides measuring your risk tolerance, you also need to know how much risk you need to take to achieve your financial objectives.

It is a useful indicator because you may realise that you do not

really need to take the risk of investing in that product after all.

Perhaps your risk profiling score indicates that you are an aggressive investor who can withstand high portfolio volatility.

But there may be no need for you to undertake the new risk because you may be already close to meeting your financial goals.

The need to take risk – called risk capacity – is based on what returns a client needs based on his objectives.

Depending on the returns he needs, his need to take risk can then be determined, said Mr Tan.

The rate of return needed can be estimated by considering your investment time horizon and financial goals.

Say you need $1 million to meet your retirement income goal of $40,000 a year.

Based on current savings of $100,000 and monthly additions of $300, it means you need to achieve a return of 6.4 per cent a year in 30 years, said Mr Patrick Lim, associate director at financial advisory firm PromiseLand Independent.

To reach this, you need to take on a certain level of risk, which is your risk capacity.

The information is then used to decide on the types of investments to buy and the level of risk to take on, which can be low, medium or high.

3 Ability to take risk

The usual risk profiling exercise carried out at most financial institutions helps determine your willingness to take risk but it does not re-present your ability to take risk.

Let’s say the risk profile questionnaire indicates that you are a high-risk investor, but if you look at your financial health and commitments, it may show that you have a lot of debt. This means that you are unable to take high risks even though your risk profile says otherwise.

Mr Tan’s firm gauges a client’s ability to take risk by conducting a comprehensive financial planning process.

At Providend, this usually requires four client meetings spread over two months to learn a client’s investment objectives, phase of investing, financial and physical health, insurance and personal situation such as his family commitments and so on. All these will determine a client’s ability to take risk.

At wealth management firm dollarDex, chief executive Chris Firth said that risk ability should be a ‘holistic’ concept that looks at salary, income, expenses, emergency savings, insurance coverage and goals before determining a client’s ability to lose money on an investment.

Mr Ronnie Lim, Standard Chartered Bank’s (Stanchart) general manager of wealth management in Singapore and Malaysia, said the bank assesses risk ability through understanding a customer’s ability to meet immediate and foreseeable financial obligations after he has committed to an investment.

In DBS’ fact-finding form, the bank assesses risk ability and overall pro-duct suitability by collecting information on a customer’s investment time horizon, income level, employment/income status, financial health such as cash flow and net worth and age.


# Balancing the risk Providend maintains that using the risk profiling questions alone is insufficient to adequately suss out a client’s risk attitude. Besides assessing risk tolerance, it seeks to understand the client’s risk capacity and ability to take risk.It believes that it is able to really understand a client’s risk appetite only after these three factors are aligned.The three factors help determine the amount of risk that should be taken in a portfolio of investments.

The problem many investors face is that their risk tolerance, risk capacity and risk ability are not the same.

This is where the adviser’s responsibility comes in. Even if an investor appears to have an appetite for a product with a certain amount of risk, the adviser must steer him away if he feels that the client does not have the capacity and ability to take the risk, said Mr Stanley Jeremiah, council member of the Singapore Insurance Institute.

‘For instance, the doctor cannot say he prescribed sleeping pills because that was what the client wanted. In the same way, the adviser or the financial institution cannot say that he or it sold a client a high-risk investment which was not suitable for him because of the client’s lack of risk ability, simply because that was what the client wanted,’ said Mr Jeremiah.

‘As professionals, they owe a duty of care and they should give professional advice including advising an eager customer against investments which are unsuitable for the customer.’

Mr Tan agreed, saying: ‘We don’t give in to a client’s wants. Only a salesman does that. We are a fiduciary, we advise clients and sometimes that means going against what they want.’

Mr Lim said that when customising a portfolio, StanChart considers a customer’s risk capacity and ensures that thresholds are adhered to.

In a scenario where making an investment would result in a breach of these thresholds, the bank will either advise the customer to reduce his investment amount to a level within his risk capacity or advise him against making the investment.

Useful tools to access your attitude to Risk

Risk Profile Tool