What’s A Risk Profile And Why Does It Matter to You?

Ahh, the dreaded risk profile questionnaire. Whether you’ve been to see a Financial Advisor before or not, you’ve probably come across some version of this before.

If you’re not sure what we’re talking about here, a risk profile questionnaire is a series of questions designed to assess your tolerance to risk, and your ability to take risk, when it comes to investing. 

Risk profile questionnaires may be a little boring, but they do serve an important purpose. And look, even if they didn’t, the government says we have to do them, so there’s no getting out of it anyway.

There’s a key point worth mentioning here. In self service investment apps, the onus is on you, the investor, to choose a portfolio that matches your risk profile. With a money manager, it’s their job to ensure the portfolio is right for you.

It’s an added layer of protection that comes with using a professional rather than a typical trading app.

So if you have to do one before investing, let's make sure you know what the whole point is, how they work and how to weave your way through the (sometimes strange) questions to get to a risk profile that’s right for you.

Why do you need a risk profile?

Whenever you invest money, there is some element of risk involved. Depending on what you invest in and how you invest, the word risk could mean the potential to actually lose everything you put in, but more likely, it just means the amount of volatility you're prepared to put up with.

A risk profile helps provide some guidance on what the right level of risk is for you.

Because there is no such thing as the ‘best’ investment for everyone. A 35-year-old lawyer who plans to retire at 65 is going to want to invest very differently from a 60-year-old retiree. The level of risk they are prepared to take is likely to be different, and so is the level of risk they need to take to have the type of financial freedom they want.

Especially if you’ve not invested much before, the risk profile process can help you understand how you might feel under certain conditions. 

A common question asks you the maximum drop in value you would be prepared to accept before you made a change?

Rather than just ticking the first box that comes to mind, it’s really worth thinking about that question. 20% is just a number, and many first-time investors find it easy to click that button when answering that question.

But if you’ve invested £300,000, then a 20% drop means your portfolio has gone down to £240,000. How would you really feel about that?

So while, yes, a Financial Advisor has to have you complete a risk profile to make sure the regulators are kept happy, if they’re completed with some thought, then they can be really valuable for your investment journey as well.

Common risk profile misconceptions 

When it comes to completing a risk profile, some of the questions aren’t necessarily that clear. This is important, because a slightly different interpretation of the question can make a big difference in how you answer. 

Those differences can mean you could be assessed at a level of risk that isn’t accurate, and in the long run it could add up to thousands of pounds of missed investment returns. So yeh, it’s important to get it right.

So let's go over these misconceptions to make sure you’re on top of the fine print when it comes to answering the questions for yourself.

Time horizon explained

One of the questions we ask is about your investment time horizon. You’ll find this one in every single risk profile questionnaire you complete, and it helps gain an understanding of how long your funds are likely to be invested.

The common misconception here is that the question being asked is how long you plan not to touch or move a single penny of your funds. 

That’s not necessarily the case.

This question is really asking how long you are prepared to keep the majority of your funds invested. That doesn’t mean they have to be invested in the same place or with the same financial firm for that entire time.

If you say your investment time horizon is longer than 5 years, it doesn’t mean that you’ll never move that cash around. Perhaps you move from one ISA provider to another. Or change Financial Advisors and move everything over to a new platform.

Maybe you even take £10,000 out of your £250,000 to cover a part of a holiday. The key is that the bulk of the funds will remain invested throughout. 

Can be changed

One of the other major misconceptions around the risk profile is that they are set in stone. The level of risk you decide to take with your investments as a 35-year-old is the level you’re stuck with for the rest of your investment life.

That’s not true.

In reality, a risk profile is something that is reviewed at least once a year and is changed based on your attitude, experience and objectives. That’s not to say that it should be changed regularly, but if there has been a material change in your circumstances, it can make sense to do it.

For example, many clients who haven’t invested before prefer to start with a more cautious investment. As they gain more experience and understanding of how markets work, once they’ve lived through a few market crashes and lived to tell the tale, they’re happy to bump up their risk level.

The important thing is that it meets your objectives and allows you to sleep at night, and that’s bound to change over time.

Losses aren’t necessarily forever

Another common question on risk profiles (including ours) asks about your feeling towards investments with large potential for gains compared to large potential for losses. With this question, it’s important to keep in mind the context of what you’re considering investing in.

If you’re thinking of crypto, then yes, you need to be very aware that you could lose a large amount (or all) of the money you put in.

But when we’re talking about mainstream investment portfolios that allocate funds to large-cap companies in stock markets, the risk of a permanent loss is significantly different to something like crypto or angel investing.

Really what we’re talking about in this context is how much volatility you can put up with. Take the tech sector in 2022 as an example. Essentially every tech company has seen their stock price plummet throughout the year.

Investors could be sitting on significant losses within their portfolio. But unless they sell these holdings, the likelihood is that over a long enough time period and as long as they’re diversified enough, those losses will be pared back.

Is it realistic that Microsoft, Google, Meta, Apple, Amazon and every other Silicon Valley behemoth will never recover to beat their previous high? Probably not. It might take some time, but there’s a good chance that it will happen eventually.

To reiterate, this concept only holds true with a well-diversified portfolio. Not individual investments or stocks. Even the biggest names can fall and result in a total loss for investors.

Getting your risk right

The risk profile might seem like an annoyance in the investing process, but it can be really useful in understanding your own mindset around investing.

Remember that it’s not set in stone and that it will likely change over time as your attitude towards investing and your circumstances change.

You can complete your own simple risk profile questionnaire for free on our app, or if you’d like to talk through anything to do with investing and risk, simply book in a call with one of our advisors.