The most ridiculous question a financial advisor can ask his client is: "What is the level of risk you are comfortable with?"
Ironically, every advisor asks this. Some just ask, while some use sophisticated tools for risk profiling. All of them, in the end, are trying to arrive at a risk quotient - something comfortable to the client.
Because everything we do revolves around risk and risk management. The latter is a disguise to do something we don't understand properly.
A good financial advisor is concerned about your overall financial well-being. He is supposed to work in consultation with you to get the best results.
The financial advisor recommends the risk level to you. He analyses your situation, understands what you have and how much you will have in years to come. He calculates what you need over time given your financial goals and aspirations.
Once you understand this properly, he figures out the rate of return required for each of your financial goals. Then, this rate of return, or asking rate for a given goal, dictates the broad level of asset allocation and, ultimately, the risk you must take.
Only then, after all the mathematics, does the advisor choose and recommend products or product categories. This is when you will discuss risk preferences.
The advisor must know your risk preference. This can happen only if he does not let himself get biased with your preference. Else an accurate solution may not be possible.
What is risk? It is not about investing in equities as is commonly understood. An appropriate definition of risk is doing something that may be detrimental to your financial health.
Let's consider someone who is getting an early retirement, or VRS. Say he is 55 and has Rs 30 lakh (Rs 3 million). If he was asked to put all his money in fixed interest instruments, that is risky. His capital is protected, but what if there was a contingent medical expense? How can he fund that?
Let's assume this money was invested at 8 per cent to get Rs 240,000 per annum. What happens after five years, when inflation reduces the real value of Rs 240,000 to Rs 180,000? Isn't running out of money during retirement risky?
Here is another example: A 30-something couple has a ready down payment of Rs 500,000. They don't know when they want to buy a house - it could be six months or 30.
Since they are young, placing that money in equities or equity mutual funds because the markets have corrected by 15 per cent is disastrous and very risky.
Asking them their risk profile and given that they are willing to invest 100 per cent in equities does not mean they should be advised equity investments blindly without consideration of other implications.
There are no set standards. Customisation is essential at each step. Most times, risk is equal to volatility, which is so wrong. Risk is not volatility.
Doing the wrong thing is risky. Doing the right thing is not. It is prudence.
Kartik Jhaveri is an expert in Financial Planning, a Certified Financial Planner and a Certified International Wealth Manager. He may be reached at kartik.jhaveri@transcend-india.com.
Disclaimer:
The contents of the above articles are the intellectual property and copyright of the author, Kartik Jhaveri. No part may be used or reproduced in any form or manner. If you choose to act upon the information contained in the above article it is at your own risk. This article is purely educative and you are strongly advised to consult an expert prior to taking any significant decision.
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