What is a 'Risk Profile'
A risk profile is an evaluation of an individual or organization's willingness to take risks, as well as the threats to which an organization is exposed. A risk profile is important for determining a proper investment asset allocation for a portfolio. Organizations use a risk profile as a way to mitigate potential risks and threats.
BREAKING DOWN 'Risk Profile'A risk profile identifies the acceptable level of risk an individual or corporation is prepared to accept. A corporation's risk profile attempts to determine how a willingness to take risk (or aversion to risk) will affect an overall decision-making strategy.
Individual Risk Profile
In general, a greater risk associated with any investment should require a greater return. Either risk profile – whether used to describe the willingness to accept risk or an evaluation of the risks to which an entity is exposed – can be expressed in a graph. Risk is often measured in terms of risk probability (the likelihood that a risk will occur) and risk impact (a measure of the consequences if the risk occurs). Investors can evaluate the risk to which a portfolio is exposed and make decisions based on this risk and their willingness to accept risk.
To develop an individual's risk profile, the level of acceptable volatility and willingness risk to principal need to be established. For example, investors who want no risk to principal should not invest using stocks. Stocks may have attractive long-term gain potential, but investors must be willing to accept fluctuations in the market. Certificates of deposit (CDs) offer much lower returns, but the principal amount is guaranteed. Each investment has an appropriate risk level that can be measured using financial statistics. Standard deviation, beta and alpha can be helpful for investors looking to measure the risk and volatility of a particular investment or portfolio.
Organizational Risk Profile
A risk profile also illustrates the risks and threats faced by an organization. It may include the probability of resulting negative effects, and an outline of the potential costs and level of disruption for each risk. It is in a corporation's best interest to be proactive when it comes to its risk management systems. Some risks can be minimized if they are properly accounted for. Corporations often create a compliance division to help in such endeavors. Compliance helps ensure that the corporation and its employees are following regulatory and ethical processes. Many companies hire independent auditors to help discover any risks, so they can be properly addressed before they become external issues.
Failing to minimize risk can lead to a negative consequence. If a drug company does not properly test its new treatment through the proper channels, it may harm the public and lead to legal and monetary damages. Failing to minimize risk could also leave the company exposed to a falling stock price, lower revenues, a negative public image and potential bankruptcy.