How Should We Approach Investment Risk?

To kick start the New Year, Andrew attended a conference discussing the nature of ‘risk’ and the way in which the UK regulators, advisers and public perceive it.

The concept of ‘risk’ has been recently brought to the forefront by the Financial Ombudsman.  In a particular case, the spotlight was turned to an adviser for recommending a high risk fund structure for a cautious investor who preferred cash.  Despite the adviser’s choice outperforming the cash alternative, the adviser was penalised and lost the case.

In recent years, we have used the FinaMetrica assessment tool in an attempt to gauge our clients’ risk tolerance, and match this with the required level of risk to serve their objectives.

For those clients who are happy to then enter the market, your score helps us asset allocate within your comfort zones.  Should you rather avoid risk when pursuing your objectives, cash is the perfectly acceptable alternative (as long as the institutional risk is covered).  This is under the premise that interest does not provide real capital growth, and growth is in fact negative when faced with inflation.

Unfortunately, having sufficient capital to achieve your objectives is very unusual without growth.  We typically assume 4% growth on funds after all charges (perhaps 5.5% gross), which means you have to take risk regardless of your preferences.   If a high level of return is required to meet a client’s goals, we are therefore sadly left with two options: accept greater risk or adjust your objectives.   With the recent changes to pension funding, we are no longer looking to reduce portfolio risk as clients grow older.  With the mind of passing any remaining funds onto your dependants, we are in fact investing for both you and the next generation as well.

Bearing the above in mind, we are into unchartered territory.  With the cost of guarantees now so high, most of us cannot afford to take them.  Although unsettling, all investors must ultimately accept that nothing in the future will be a “sure thing”.  We will of course do our utmost to guide you through the uncertainties we all face.