How to assess your risk profile
When entering the world of investing, one of the first steps is to understand your risk profile, that is, how much risk you are willing and able to take. The goal of understanding your risk tolerance is to make the most coherent decision for each situation so that, once you choose the right strategy to grow your money, it doesn’t cause financial stress.
In the book “Haz crecer tu dinero” (Grow Your Money), the economist Daniel Lacalle highlights the importance of knowing your profile to tailor your investments to each circumstance. He suggests taking a simple test that can help you identify your risk profile and understand the different types of investors.
What is a risk profile and why is it important?
Your risk profile reflects both your ability and willingness to take losses when investing, both emotionally and financially. Not everyone has the same tolerance for risk, so knowing yours will allow you to adjust your investments in a way that makes you feel more comfortable, minimizing financial stress while maximizing growth opportunities for your capital.
Each investment carries a different level of risk: some assets, like government bonds, are safer but offer lower returns, while others, such as stocks or real estate, may have greater growth potential but are also more volatile. For this reason, understanding your risk profile is key to selecting the right combination of assets to meet your goals.
Take the test to find out your risk profile
Here are some key questions to help you better understand your risk profile. Answer honestly, keeping in mind that there are no right or wrong answers—they simply reflect your personal preferences.
1. How long are you willing to hold your investments?
If you see your investment gains as a possibility in the long term (5-10 years), you may tolerate more risk and therefore have a more aggressive profile, as investments tend to recover from market fluctuations. If you need your money in the short term (less than three years), you’re likely a more conservative investor and should opt for less volatile investments.
2. How do you react to losses?
If you can handle temporary losses with the hope of better long-term results, you may have a moderate or aggressive profile. On the other hand, if a 10-20% loss in your investment’s value would cause you significant worry and lead you to sell quickly, you probably have a conservative profile.
3. How important is stability in your investments to you?
If you prefer to avoid surprises and prioritize security over growth, your profile is more conservative. If you aim to maximize your returns and are willing to endure fluctuations in asset values, you have a more risk-tolerant profile.
4. What percentage of your savings are you willing to invest?
If you feel comfortable investing only a small portion of your capital to avoid losing too much, you’re more conservative. If you’re willing to invest a larger portion of your savings to achieve higher returns, you lean towards a more aggressive profile.
What is your risk profile?
After reflecting on these questions, you should be able to identify your risk profile. Daniel Lacalle, in his book, classifies profiles into three main categories:
– Conservative profile: This type of investor values security and stability over high returns. Their main goal is to protect their capital, so they opt for low-risk investments such as government bonds, money market funds, or fixed-term deposits. While returns are usually lower, so is volatility.
– Moderate profile: The moderate investor seeks a balance between risk and return. They are willing to take on some risk to achieve higher returns, but without exposing themselves to major fluctuations. They typically combine low- and medium-risk investments such as balanced mutual funds, stocks in established companies, or real estate with a more stable focus.
– Aggressive profile: This investor is willing to take high risks in pursuit of high returns. They are prepared to endure significant short-term fluctuations, expecting substantial long-term gains. Investments in stocks, cryptocurrencies, or high-yield real estate projects are well-suited to this profile.
In conclusion, before you grow your money, it’s essential to understand your risk tolerance level before starting to invest. Once you know your profile, you can build a balanced portfolio that maximizes growth opportunities while reducing financial stress.