The importance of understanding your risk profile

It is said that life is all about taking risks, if you never take risks you will never achieve your dreams. When it comes to investments it is a no different story here though with certain conditions and those conditions are your ability and your willingness. Everything would filter down to these two things. We face risks in every walk of life then may it be the risk of an accident when we are travelling or the risk of losing the job on which our family depends. So the risk is one of those factors which can never be avoided. The question that arises here is what we can do about risk? We can try our best to reduce it to a certain extent matching our level of its tolerance.

So what do you mean by risk profiling? 

Risk profile means gauging an individual's willingness and ability to take risks. The main objective of risk profiling is to simplify the process of understanding attitudes towards investing and try to understand probable reactions to future events. For instance, when markets collapse, how one reacts, whether they hold their position, buy more or sell all in panic. Everyone thinks and act differently. Specifically, when it comes to making decisions, one's reactions tend to be significantly influenced by their attitudes, mindset, past experiences and current situation, etc.

Now the question is why is it important to understand your risk profile? 

The hard truth is that you may never know how your reaction to a particular market situation will be unless you actually experience it. Steep market falls have stripped many brave investors of their ability to hold on to their investments. Proper risk profiling ensures that your asset allocation is in line with your attitude and other psychological attributes and current situation.

This will allow you to make better decisions when it comes to your money by neither panicking and selling off investments nor investing out of greed. It is the rate of return that an investment is going to generate is generally the first thing that is thought at the time of investment. Though it is definitely a very important factor, it is equally important to understand the risks associated with that particular investment. Risk profiling often helps people to pass the sleep test. If your investment returns are keeping you up at night then you are probably not invested in a way that is right for you and which matches your tolerance level.