My Investment Risk Profile

Profiling our own investment risk is a very subjective issue. Risk profiling is very much individualistic (i.e. one individual or one family) and I believe everybody would have a unique risk definition. Now it is likely that qualitatively the risk profile could be classified in similar groups. However, quantitatively it would different for each individual.

I view my risk profile as a three-dimensional measure. These three dimensions of risk 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 dollar amount. e.g. Do I have one million dollar for investments or do I have only $10K to invest or $1000 at regular intervals.
  • Tolerance is how much volatility in my investments I can afford. This could be percentage based or actual dollar amount.

I have mapped my risk profile on these three dimensions. I have defined three different time scales based on my (i.e. my family) current-state-of-finance.

In short-term (i.e. next 2-3 years), I expect expenses for buying our first house and perhaps buying one additional car. In this case, I have planned dollar 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 expected expenses and family’s projected state-of-finance, I am willing to allocate a certain dollar amount that can tolerate some level of fluctuations. e.g. a $10K invested may go down by 25 to 30%. I have a problem if it goes down by 50%, because given the timeframe, this investment can become a negative preposition. My opportunity-based portfolio (and index-based portfolio to certain extent) is targeted towards this intermediate-term. The key characteristic here is smaller number of positions for ease of manageability. One of the very significant aspects on this is rebalancing. I cannot overemphasize this, because rebalancing helps nibbling winners.

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. My dividend-focused portfolio is a long-term strategy. This blog spot focuses on this aspect of my risk profile.

With this definition of my risk profile, I frame my investment strategy and different investment buckets. It allows me to allocate capital accordingly.

One Response to “My Investment Risk Profile”

  1. Anonymous says:

    Hello DT,
    I like your method of risk profile. Reading this post was an excellent learning experience.

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