I remember when I first started investing, I was a bit nervous about losing my money and stuck with value stocks that had large market capitalization, extremely high trading volumes and that were very widely held. That changed over time as I got more educated and confident in my stock picking ability. At that time I fell into a risk profile category and like most investors, it shifted with age and became fine-tuned as I acclimated to the markets. Each stock investment, whether it be made directly, or indirectly (eg through ETFs or mutual funds) has a different risk profile. So understanding your risk category is mandatory if you want to make the right stock investment choices.

Risk Categories

There are numerous risk profiling techniques and various categories established, but investors typically fall into the following general categories:

1. Conservative/Risk Adverse: This is an investor who does not want to lose any capital and counts on the investment streams to pay for day to day living expenses. Typically these investors are retired with a fixed income stream and have a short time horizon.

2. Moderate Conservative: Similar to #1, but this investor wants to participate a bit more in market rallies although wants maximum downside protection.
3. Moderate: This is the most common category- the middle of the road. These investors are looking to invest for the long term with a specific goal in mind (college savings, retirement, etc.) Usually their overall portfolio looks most similar to the S&P 500 market index.
4. Moderate Aggressive: Investors who are willing to take on more risk to realize higher returns fall under this category. They are okay with higher downside risk than the market, but expect to be substantially compensated when markets go up. These investors have the goal of accumulating vast amount of wealth in the future, and are willing to wait a significant amount of time for the rewards. They produce little income in the short term.
5. Aggressive: This last category is the “no- holds barred” investment category. These investors are willing to withstand large fluctuations in portfolio returns to produce returns substantially above the market in the long term. They usually have an extremely long time horizon so that they can recoup losses. They also tend to be younger, or have had minimal experience investing during down or bear markets.

Each of these investor categories has a particular stock type that fits his risk profile:

1. Conservative: Shies away from any stock investments and focus more on cash or money market investments or high quality short to intermediate term bonds. Since this investors want to avoid any loss of capital, investing in stocks is typically not in their bailiwick.
2. Moderate Conservative: Prefers a portfolio with significant exposure to high quality fixed income securities and inflation-linked investments like cash, real estate and some commodities. They can withstand several different types of stocks with particular focus on the income generating and stable low beta names. The typical income generating stock is one that provides a dividend, not only today but has a history of providing a strong payout which has never wavered. Although these investors tend to stay away from high beta, smaller cap and non-developed market stocks, they can invest in defensive sectors that have betas less than one (indicating lower risk than the market).
3. Moderate: A mixture of value and growth stocks to achieve a balanced risk/reward portfolio categorizes this type. Diversified mutual funds and ETFs that reflect broad market indices like the S&P 500 are often used.
4. Moderate Aggressive: Focus on growth and momentum stocks that have high betas with little emphasis on value or income stocks.
5. Aggressive: Typically hold mostly growth, momentum and speculative names that are often small-cap, and non-diversified sector mutual funds or ETFs.

The Bottom Line

Without a proper understanding of the level of risk investors are willing and able to accept, the choice of security may fail to provide the expected risk/return mixture, causing conflicting buy/sell decisions such as buyer’s remorse or fear of selling.