When we first meet with a prospective client it is important to gain a complete understanding of their financial goals and what they hope to achieve through financial planning. As part of this process, we will need to discuss a wide range of subjects with an individual/couple, covering their income requirements, what other objectives they may have and the extent to which they want to provide for other family members both during their lifetime and beyond.
One of the key aspects of financial planning is determining a client’s Attitude to Risk and Capacity for Loss. Attitude to risk is defined as a client’s willingness to tolerate swings in the value of their investments for the prospect of increased returns. Capacity for Loss indicates a client’s ability to absorb short term losses for the prospect of increased returns. Capacity for Loss is closely linked to a client’s ability to earn income and their overall asset position.
Whilst we would all like to greatly increase the value of our wealth with little or no risk, this isn’t a realistic possibility. When it comes to investments there will always be a level of risk involved – even in everyday savings vehicles such as pensions or ISAs.
Overall risk increases as you begin to look at stocks and shares investments. Here are four considerations that should be made in relation to risk when putting together an investment/wealth management plan.
Short vs long term approach
The stock market is an extremely volatile environment and the value of stocks and shares can increase or decrease dramatically overnight depending on an almost endless number of events and scenarios. Timing markets over a short period of time is very difficult and extremely risky. A long term approach is preferable as over time the stock market tends to reflect the overall growth and productivity of the economy. Taking a long term approach to investing in the stock market is therefore something we would recommend to all clients – no matter their attitude towards risk.
Finding the balance
Part of the role of a financial adviser is to build an understanding of a client’s Attitude to Risk & Capacity for Loss such that they can create a portfolio that effectively balances the amount of risk the client is willing and able to take with their return aspirations. In general terms, there are four main investment asset types – cash, bonds, property and stocks and shares. Any investment portfolio will consist of a range of investments across some or all of these asset types.
Investors with an Adventurous Risk Profile (indicating a less averse Attitude to Risk and high Capacity for Loss) will likely end up with a portfolio that is more heavily weighted in stocks and shares than in cash. For clients with a Cautious Risk Profile (indicating a lesser Attitude to Risk and lower Capacity for Loss), advisers would propose a portfolio with a much lower level of associated risk.
Each and every client will have a slightly different combination of each depending on their risk profile and the various other variables that make up their overall attitude.
Realistic expectations
Whilst most clients understand the concept of ‘the greater the risk, the greater the potential reward’, the issue comes where there is discord between perceived risk and expectations. From the outset, the financial advisers at Gresham will present a realistic set of scenarios, each with a different level of associated risk.
Review and monitoring
Attitude to risk and Capacity for loss can change over time – sometimes due to life events or simply a change in attitude as one gets older. As such, it is important that risk is reviewed on a periodic basis to ensure that portfolios stay aligned to clients’ attitudes and situations.
For more information about our approach to dealing with new clients or to arrange an initial conversation with one of our Independent Financial Advisers to discuss your wealth management strategy, please get in touch.
NB. The value of investment can fall as well as rise. You may not get back what you invest.