An investor’s risk profile is an essential element in determining the suitability of an investment product. There are two facets to this—the ability and the willingness to take risk.
The ability to take risk takes into account things such as the age of the investor, level of income of the household, income security, investment horizon and so on. Typically, a young investor who has a secure income is able to take more risk for a long-term goal. The same investor’s ability to take risk for a near-term goal will be lower and, accordingly, the investment choice will be different. It’s also important to consider the willingness to take risk. An investor may be uncomfortable with higher levels of risk even if they are able to take risk. Older investors with less experience and understanding of markets and investments may be unwilling to take greater risk even for better returns.
Risk profiling questionnaires are typically used to determine an investor’s attitude to risk before an investment product is suggested.
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