Risk scoring is a simple yet clever hack that addresses an investor’s risk-taking ignorance and adds a certain amount of professional finesse to portfolio construction.
A risk assessment provides investors with knowledge of their risk appetite and helps them determine whether an investment is suitable for their portfolio. This reduces the likelihood of risk shocks and keeps the portfolio on track toward long-term wealth accumulation without being disrupted by short-term bear markets or corrections.
Risk assessment forms the basis of a sophisticated, three-step, risk-oriented portfolio construction process practiced by professional investment advisors and experts.
• Investors undergo a risk assessment to determine their risk-bearing capacity.
• This risk level serves Investment portfolios are selected with a historical risk level that matches the target risk level.
• Investment portfolios proven to produce the highest returns are selected.
This risk-assessment-based approach allows investors to choose optimal portfolios designed to maximize return potential within a set target risk without being swayed by short-term volatility surprises or risk shocks. Because investment losses remain within expected limits, risk assessment brings consistency, science, discipline, and purpose to portfolio construction, greatly increasing the likelihood of realizing promised return potential.
Two people, even from the same socio-economic class, can have very different personal/economic realities. Personalization is central to the risk assessment approach, enabling us to design optimal investment portfolios as well as increasing our chances of success over other approaches driven by the one-size-fits-all.
Risk assessment is not a one-time activity. To maximize its potential, a risk assessment should be conducted after any significant financial/personal event. It enables risk assessment as an effective tool for creating and maintaining optimal investment portfolios over the investment horizon.
Steps and precautions to consider before portfolio creation
Assess Risk Tolerance
Risk and return are usually inversely related. The more risk an investor takes, the higher the potential return they expect. Individual stocks are generally riskier than government bonds. Cash carries little to no risk, other than the potential loss of purchasing power over time. Because of the higher risk, stocks have higher return potential and lower yields than government bonds but are much more stable in value.
Diversify Investments
The next aim should be to build a diversified portfolio offering you optimal returns while also safeguarding corpus from undesirable eventualities.
Allocate Assets Wisely
Tracking your investment performance allows you to correct course on time. But don’t react prematurely to poor performance. For example, the stock market is volatile, which can underperform equity investments and affect portfolio returns.
Rebalance Portfolio
Regular reviews also help assess whether we are adhering to our asset allocation strategy. Without regular adjustments, the portfolio may become too aggressive or conservative concerning its risk profile, making it less likely to meet its objectives.
Risk Management
Portfolio risk management is one of many portfolio management processes, but it has a specific role that affects the entire portfolio. It is about planning, assessing, and responding to risks.
To achieve the desired level of overall risk or tip the scale on the positive side, a portfolio risk management plan needs to be developed. However, because of the downstream impact on portfolio components, portfolio risk management must address the root causes of potential threats. In other words, remediation of negative risks should be done at the root level. However, positive risk capitalization must be done at the organizational and portfolio level.
Developing a portfolio risk management plan begins with a risk management plan that describes the structure of risk management activities and how they will be carried out. This is where the plan is created and completes the procedures, schedules, and references to corporate policies, risk management policies, and procedures that define the organization’s risk tolerance, thresholds, and strategies.
