Attempting to determine our own investment risk profile is very subjective aspect. This is because of personal bias creeping into our analysis, natural tendency to be perennial optimistic, and biasing due to business media projections. I believe that risk profiling is very much individualistic (i.e. one individual or one family). Every individual will have a unique risk definition. Now it is possible that qualitatively, the risk profile could be classified in similar groups. However, quantitatively it would be different for each individual.
I view my risk profile in three different dimensions. These three dimensions of risks are (1) Time; (2) Capacity; and (3) Tolerance.
- Time is associated with my financial goals and what I want achieve in short-term, intermediate-term, and long-term.
- Capacity is how much I can afford and how much I can stretch in my investments. This is an actual Rupee amount. e.g. Do I have ten lac rupees for investments, or do I have only ten thousand rupees to invest, or do I have only ten rupees at regular intervals.
- Tolerance is how much volatility in my investments I can afford. This could be percentage based or actual rupee amount.
In short-term (i.e. next 2-3 years), I expect expenses for buying our first apartment, perhaps one additional transportation vehicle, and cash reserve for six month worth of expenses. In this case, I have a planned rupee amount (i.e. capacity) for which I have zero tolerance. Therefore, all of my investments are in fixed income vehicles. Here there is nothing to manage. Practically, I spend zero time managing this part.
In intermediate-term, i.e. next 6-8 years, based on our projected expenses and family’s projected state-of-finance, I am willing to allocate a certain rupee amount that can tolerate some level of fluctuations. Let us take an example. I have no issues or problem if my one lac rupees investment may go down by 25 to 30%. However, I have a problem if it goes down by 50%, because given the timeframe, this investment can become a negative preposition.
In long-term, i.e. 10 years and beyond, I am willing to allocate capital that can take higher fluctuations. Longer timeline builds-in wider tolerance, because I do not have any immediate need to access this capital. A sub-part of my income portfolio is a long-term strategy. Majority of this discussion on this blog will focus on this aspect of my risk profile (long-term income generation).
With this definition of my risk profile, I have framed my investment strategy and different investment buckets. It allows me to allocate capital accordingly. I will discuss in this future posts.
What is your investment risk profile? What process do you use for capital allocation? Let me know using comments sections below.