Would you consider yourself a “risk-ponsible” investor? Are you aware of your risk profile? That is, are you a conservative, moderate, or aggressive investor? These are key questions every investor should ask at the start of his or her investment journey. In a previous article, “Understanding How Much Risk is Right for You”, we explored the importance of knowing your risk profile for successful investing. Today, we will delve deeper into factors you should consider to help determine your ability (risk capacity) and willingness (risk tolerance) to take on risks. To accurately understand your risk profile, you need to explore your financial position and conduct an honest self-reflection. By reflecting on your risk profile, you can align your portfolio with your financial goals and invest confidently.

Factors that Influence Your Risk Capacity

Risk capacity refers to the amount of risk you can comfortably take to reach your financial goals. This includes factors like the amount you have to invest, how long you want to invest (time horizon), and age. Take a moment to consider how each of the following factors would apply to your unique situation.

• Available capital/portfolio size:

Aside from your investments, do you have adequate funds (savings, income, insurance) to meet your needs? Do you earn enough to cover your expenses and regularly add to your investment portfolio? If the answer to this is yes, you may be able to take on higher risk. However, if you rely heavily on your portfolio to cover daily living expenses, your risk capacity is likely low. Is the size of your portfolio closer to $10 million or $100,000? If an asset in your portfolio loses value (assuming it is a well-diversified portfolio), the percentage loss is much less in a larger portfolio. Therefore, the larger your portfolio and your net worth (excluding investable assets) the higher your capacity for risk.

• Time horizon for your financial goals:

When do you plan to use or draw on the money you invested? Are you saving for a short-term goal like a wedding, vacation or down payment for a home, or a long-term goal like retirement or college education for young children? If your time horizon is long-term, i.e. greater than 10 years, it normally indicates that you have a higher risk capacity. However, if your horizon is under five years, it represents a lower risk capacity, as there is less time to recoup portfolio losses resulting from market volatility. An intermediate time horizon falls between these two points.

• Age:

What stage of life are you at? Are you close to retiring or have you just started your first job? Typically, all other things equal, younger individuals have a higher risk capacity as they would have more time to recover from adverse changes in the market.

Note that your risk capacity can change with time. For example, it will change with your circumstances like age and income.

Factors that Influence Your Willingness to Take Risks

Your willingness to take on risk is more subjective than your risk capacity as it represents the maximum level of uncertainty you are willing to accept when making financial decisions. This may differ based on gender, socio-economic or cultural differences, and personal experiences. Psychometric questionnaires and similar tools are typically used to assess your willingness to take risks. These assessments may include questions to determine how comfortable you are with taking risks and the impact of losses on your investment knowledge and experience.

•Personality type:

How do you handle risk? What is your reaction to actual or potential losses in your investment portfolio? Each investor handles risk differently and has varying comfort levels based on their personality and life experiences. Some strive to avoid risk entirely while others embrace it and most will land somewhere in between and be comfortable with taking some risk.

•Investing experience:

How many years of experience do you have as an active investor? How many investment cycles have you been through? Generally, there is a positive relationship between risk tolerance and investing experience. More experienced investors are often more comfortable with bouts of market volatility as they have become familiar with market patterns and tend to have higher tolerance levels.

By establishing a clear plan for your financial goals, assessing your current financial situation, and understanding how your personality and experiences affect your financial decisions, you are now well equipped to determine the optimal level of risk for your portfolio. The interplay between risk capacity and willingness to take risks ultimately determines your risk profile. If your risk capacity and willingness are high, you’re likely an aggressive investor. If both are low, you’re likely a conservative investor. Those with medium risk capacity and willingness are typically moderate investors. Having reflected on some of the factors that shape your risk profile, what type of investor are you: conservative, moderate, or aggressive?

You’ve identified your risk profile: What’s next?

Once you’ve identified your risk profile, it’s a good idea to work with a trusted investment advisor to construct a portfolio that aligns with your needs, goals, and risk profile. Additionally, a financial advisor can recommend suitable investment, asset allocation, and diversification strategies based on the information you share. If you’ve already started your investment journey, but are unsure of your risk profile, take a moment to do an assessment, with your advisor’s guidance. After determining your risk profile, check if your existing portfolio aligns with your risk profile. Contact an NCB Capital Markets wealth advisor today to help you assess your risk profile and optimise your portfolio’s risk-reward balance, ensuring it’s right for you!