Risk Profiling of Individual Investors

HIGHLIGHTS

• Risk profiling is at the corner of the investment management process for individual investors.Understanding an investor’s risk tolerance levels and investment preferences and targets are key to managing a successful long term investment relationships.
• In the wake of the global financial crisis, regulatory authorities around the world started to impose measures on investment managers aimed at protecting the best interest of individual investors, ensuring product suitability, and reducing the risk of misselling.
• Well-designed and relatively simple risk profiling questionnaires that employ psychometric analysis and have their questions framed correctly would usually do a good job in identifying the risk tolerance level of investors which is the combination of their risk capacity and risk appetite.
• Risk tolerance, however, only -+represents the stable, theoretical, and long-term risk preferences of an investor. It does not adequately capture the behavioral biases that affect the short-term decision making process of the average investor.
• Understanding behavioral biases, both cognitive and emotional, and integrating them into the relationship and investment management processes would significantly increase the chances that the investor would stay the course and overcome short-term distractions caused by market volatility and emotional discomfort which would otherwise hinder the achievement of the targeted investment outcomes.