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  • Business Development Is risk profiling alone enough for asset allocation?

    Is risk profiling alone enough for asset allocation?

    Read on to find out how top financial advisors use risk profiling to create asset allocation strategy.
    Nishant Patnaik Aug 7, 2014

    Read on to find out how top financial advisors use risk profiling to create asset allocation strategy.

    At any financial advisory conference, you often hear about the significance of risk profiling in creating a sound asset allocation strategy.

    However, many financial advisors are still confused when it comes to its implementation. So, to what extent should advisors depend on client’s risk profile for creating an asset allocation?

    Typically, risk profiling exercise involves a questionnaire which is meant to measure the risk tolerance and time horizon of investors. There are not any right or wrong answers, the clients is encouraged to pick choices that are most closely reflecting her situation and perspective. Basic profilers may be available free on web sites of platforms but the more evolved ones entail payment of some sort of fee.

    Cafemutual spoke to a few leading financial advisors on how they use risk profiling to create a good asset allocation strategy and to what extend they depend on it.  

    Suresh Sadagopan of Ladder7 Financial Advisories believes that the financial advisors should avoid blindly following the risk profiling of a client for asset allocation. He said, “Though risk profiling is a vital part of financial planning, financial advisors should follow risk profiling of their clients only to a certain extent for asset allocation. Advisors should keep in mind the goals of their clients. Some clients have a conservative risk profiling but their goals are very aggressive. As an advisor, our job is to make them understand that aggressive goals can be fulfilled only with aggressive allocation strategy.”

    Vishal Dhawan of Plan Ahead Wealth Advisors seconds the view and said that depending solely on risk profiling for asset allocation may not be a good idea. “Risk profiling helps in building a healthy conversation with the clients. It can be used as a first talking point. However, an advisor should keep in mind other factors like goals and market scenario before allocating his/her client’s assets.”

    “Advisors need to take a conservative approach to create asset allocation strategy. Maintaining a right balance between the client’s risk profile and financial goals is the key to asset allocation,” says Lovaii Navlakhi of International Money Matters.

    Typically, risk profiling process revolves around age, financial situation, investment goal, time horizon, and expectations to find out the risk appetite of the clients. Age plays a major role in risk profiling. Many risk profiling software packages assume that a young client has an appetite for higher risk compared to clients who are elderly. However, in practical, asset allocation differs on case to case basis. Dhawan recalls having met a young client who wanted to buy a house in a short duration and also a 65 year old person who wanted equity exposure in his portfolio; both examples going against conventional wisdom.

    “Age is considered as number of years left for earning. Hence, it depends on profession. For example, a bank professional may retire when he/she attains 60 years of age. In contrast, a business professional or law practitioner may continue working even after 60 years of age. Age is not a determinant for asset allocation,” says Suresh Sadagopan.

    “Typically, investors have their own perception. If an investor believes that equity fund is risky, she may not like equity to be a part of her retirement kitty even if he/she has a 15-20 year horizon. Also, investors may not factor in key factors like inflation while answering the questions. Hence, risk profiling may not create much difference when it comes to asset allocation. I believe the key to asset allocation is diversification,” says Hemant Rustagi of Wiseinvest Advisors. 

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