Identify Your Investment Risk Profile, Develop a Winning Strategy, Work It

If you learned how to save money successfully, sooner or later, many of us will be faced the question: “How can we invest our hard-earned money profitably — assets like shares, stocks, bonds, funds, certificates or gold?”

Obviously, you don’t want to make bad decisions that can lead you to money loss, and not the capital win.

To profit and grow your capital, you have to find the right investment strategy for you by dealing with your personal risk profile. Your risk profile will show which investments you correspond to and influences your investment strategy.

📊 Investment risk profiles

Four main factors have an impact on your risk profile:

🔹 Risk tolerance (how well you as an investor can cope emotionally with losses on your investments)

How much money are you emotionally ready to lose in the worse case?

The higher the personal risk tolerance, the higher the proportion of high-risk investments and asset diversification.

🔹 Risk capacity (the risk you can take according to your financial situation)

Do you have a regular and secure income?

The higher your regular income, the higher the risk you can take.

🔹 Knowledge of finance (Level of financial knowledge and experience with securities)

How well do you understand financial products?

The more you deal with investments, the better you can assess the risks.

🔹 Investment goal (It influences the money return from your investment that you want to achieve)

What do you want to achieve with your investment?

The higher the money return, the higher the risk you must take.

Have you given enough thought to your risk profile? Then you are ready actively to manage the risk of your investments – asset class risk* for your investment portfolio.

Asset classes* include stocks, fixed income, cash, foreign currencies, real estate, commodities, etc.

Assets you can invest in, depending on your risk-taking capability – your asset allocation strategy.

According to the book “Souverän investieren mit Indexfonds und ETFs” by Gerd Kommer (unfortunately, I could find only in the German language), we can divide asset risk into four categories we would end up as follows:

1. The conservative investor is very risk-averse and saves for emergencies. They seek stable returns and are less concerned about growth; they often lack time to actively monitor investments

2. The balanced investor tolerates a little more risk that the conservative investor. They are long-term investors who don’t need returns immediately and want to achieve some growth potential for their investments. They might entail some fluctuations in value, but with low volatility than the overall investment market.

3. The growth investor is a risk-seeking investor whose investments are more risky assets like stocks and ETFs. They want good growth potential and don’t need current returns. They face a fair amount of volatility, but not as much as a portfolio invested in equities exclusively. Such investors might be unemotional about the process while being active in portfolio management.

4. The aggressive growth investor is an investor of a very high-risk tolerance. The risk-proneness of this risky portfolio is at least 70%. They may be active day traders at online brokerages, actively follow the stock markets (even if they don’t execute dozens of trades each month).

That motivated me to implement a small quiz, that will help you define which type of an investor you are, and which asset risk you are capable of taking, and in which proportion:

📌 Take Developer-Investor Personality Quiz

🚀 Quiz implementation

• First, we’ll make sure that the answer options are assigned a specific weight: negative value for this being a more risk-averse option, and positive value for this being a more risk-seeking option.

• Then we’ll sum up all the weighted values for each question.

• Finally, we’ll determine ranges at which “conservative” investor becomes balanced, and at which balanced becomes growth, and at which growth becomes aggressive-growth.

• The result is in which range the riskiness score lies—that’s the investor profile.

Here’s a straightforward way of implementing that:

// ©2020 Ilona Codes. All rights reserved.
// Playing with weight values changes results
const weights = {
    'A': -2,
    'B': -1,
    'C': 1,
    'D': 2,
};

const determineInvestorType = questions => {
    // we initialize answer option counts
    const counts = {
        'A': 0,
        'B': 0,
        'C': 0,
        'D': 0,
    };

    // we count how many answers are of each option
    questions.forEach(question => {
        counts[question.chosen]++;
    });

    // we calculate the weighted score
    let score = 0;
    Object.keys(counts).forEach(letter => {
        score += weights[letter] * counts[letter];
    });

    // we determine in which range does the score lie
    let investorType;
    if (score < -5) {
        investorType = 'conservative';
    } else if (score < 5) {
        investorType = 'balanced';
    } else if (score < 10) {
        investorType = 'growth';
    } else {
        investorType = 'aggressive_growth';
    }

    return {
        investorType: investorType,
    };
};

Of course, the sophistication of this algorithm can be increased at will!

Your investing strategy should reflect your personal investor profile. Knowing which one you are could help you put your investments to work in a way that fits your personality, preferences, and goals. To help you figure out it quickly and easily, you can take this quiz: “What’s Your Developer-Investor Personality?”

No rush, no push! Only you are responsible for setting up your investment portfolio in the way you feel comfortable with. The test presents exemplary types of investment structures with deviations, and cannot be construed as investment advice.

💬 Conclusion

All returns are derived from an assumption of risk. Each investor has their own risk tolerance, and different investment objectives require taking on different levels of risk.

"Over 90% of investment returns are determined by how investors allocate their assets vs. security selection, market timing, and other factors.”—Brinson, Singer, and Beebower, ‘Determinants of Portfolio Performance II: An Update,’ Financial Analysts Journal

Within your asset allocation, you will want to diversify among industries, sectors, and other risk factors to mitigate downside volatility, alongside some bonds to provide an equity hedge.

That’s why you need to determine your portfolio allocation based on your propensity for risk, knowledge of finance, and investment goals.

Disclaimer: Author’s opinions are their own and do not constitute financial advice in any way whatsoever. Nothing published by IlonaCodes constitutes an investment recommendation, nor should any data or content published by IlonaCodes be relied upon for any investment activities.