Understanding market volatility and the ability to ‘stomach’ sharp market corrections is Risk Profiling. Some investors may be billionaires but cannot stomach market volatility or corrections and therefore have a low risk profile. Others who have only a few lakhs invested may want to take 100% risk with their money and handle all these ‘shocks’ very well! Finally, it would be a balanced approach to risk profiling based on financial goals which will lead to sustainable success on returns.
This is an important factor while planning investments. Trying to make a ‘quick buck’ normally leads to disaster. Only funds which you do not need for a minimum period of 3 to 5 years should be invested into equity markets or other risk related investments. This is the golden rule one must follow.
Risk Tolerance is another important facet. As investment advisers, our main role is to ensure that Asset Allocation and Risk Tolerance or risk profiling of every investor is done and asset allocation is maintained according to the investor’s Financial Goals.
In short the Financial Plan looks at the investor’s current Financial Situation, Risk Profiling and the Time Horizon of the proposed goals.
What is most critical is that irrespective of stock market movement, the financial goal of every client has to be met, based on the financial plan. Allocation into liquid vs illiquid assets, debt and equity investments, lock in vs open ended investments, etc must be clearly maintained.
"The years ahead will occasionally deliver major market declines -- even panics -- that will affect virtually all stocks. No one can tell you when these traumas will occur. Predicting rain doesn't count, building the ark does”.
- Warren Buffet
Most good advisors prepare a sound long term holistic financial plan for you based on your risk profile, define your financial goals along with you, do an asset allocation (with contingency plans built in) with you. You will surely be able to tide over challenging times without panic and with calm if you have conversations with financial advisors who can help with your risk profiling and therefore asset allocation portfolio. They are in the best objective position to help you understand and mitigate the risks of letting emotion get the better of you.