The Sky(Market) Is Falling

In a blink of an eye, it has been 3 months since my last post.

With the recent market sell down, there are many starting to get into panic mode. Hence, I thought it was a good time to revisit the topic of financial risk profiling.

Determining one’s risk profile is an important first step to establishing one’s Investment Policy Statement (IPS), which eventually sets the stage for one’s entire investment philosophy and performance measurement benchmark.

Risk profile can be divided into 2 dimensions, namely the willingness and the ability to take risk.

For willingness to take risk, it will be more of a subjective topic in human behavior. It will need to take into consideration a person’s character, emotions, knowledge and attitude. As we all know, these are very complex topics, as humans are simply not easy to comprehend. On one hand, someone may exhibit risk adversity by hoarding all their money in fixed deposits and at the same time display aggressive risk taking interest like purchasing 4D/TOTO/Big Sweep or gambling at the jackpot/casinos.

Sometimes, it is also a matter of framing. Perhaps one is very conservative about their hard earned savings over the years, having been brought up in a frugal environment and reluctant to take any risk with their funds. However, if maybe they now inherited a huge fortune, they suddenly are willing to invest aggressively with the new found wealth.

Similarly, a successful entrepreneur may seem like a risk taker. They invest aggressively into their small time business when they are in control of the Company. At the same time, they may prefer not to invest their personal wealth, shunning away from other bigger listed Company’s equity.

For ability to take risk, it will be more of a scientific topic. It is determined from the amount of assets, liabilities, income and expenses of the individual. If the assets and income side is greater than the liabilities and expenses, one has a greater ability to take risk.

After assessing the 2 dimensions, the conservative approach will be to take the lower outcome of the 2. If ability is low and willingness is high, risk profile is low and it will be good to educate and moderate one’s views and expectations to recognize the limitations of one’s financial ability. If willingness is low and ability is high, risk profile is low. However, one should consider revisiting on the reasons for the low willingness to see if there are any issues that can be resolved.

In summary, establishing the risk profile is the root of the IPS and as with most investments, they are for a goal in mind, markets are expected to fluctuate. However, that is no reason to start turning chicken little on every down turn. Rather consider it an opportunity to revisit the fundamentals and rebalance if required.