This week on the Mortgages, Money and More Podcast, Craig is joined by Financial Adviser and regular guest, Jason Murgatroyd to discuss Attitude to Risk: What does this mean and what are the implications?
What is attitude to risk?
Everybody has a different attitude to risk. It’s essentially how adventurous or cautious you are when it comes to investing money – whether you are happy to risk losing some money to potentially get bigger growth.
It’s not necessarily linked to your personality. I can think of people close to me that I would class as adventurous, but that doesn’t necessarily translate into them being adventurous investors.
When it comes to your own personal attitude towards risk, you need information and context to establish what exactly you feel comfortable with.
How can I assess my attitude to risk?
When we help clients with investments, we start by talking about holistic planning. We look at your objectives, aspirations, your current situation, what your future could look like.
Attitude to risk comes in when we talk about what they’re going to do with their money – investing it over the long term to meet their objectives and aspirations. There are six categories of attitude to risk, but you could probably break each of those categories down into a further six. You could go on and on but it’s the starting point to establish how a client feels about investing their money.
What are the different categories of attitude to risk?
At one end are clients who literally want to take no risk whatsoever. The thought of their investments going down in value at all will cause them sleepless nights. They want to keep their capital safe and secure.
The main options for this kind of client is to keep their money in bank accounts and cash deposit accounts, which have limited growth potential.
At the other end of the scale is a speculative investor with experience in the investment markets. They are driven by growth and are quite happy to accept larger fluctuations. There’s a lot of volatility in their investments, but that means there’s potential for big gains as well. Between those two polar opposite are four graduations to mark different risk appetites.
We will work through a series of questions to help establish which category a client is in.
What is Capacity for Loss?
Capacity for Loss, CFL, is a look at how serious it would be to an individual for their investment to shrink. If you think about what somebody’s actually investing, it could be a very small part of their overall wealth. It could be that with a particular investment, it doesn’t really matter if it drops significantly.
On the other hand, if you’re dealing with a significant part of someone’s wealth their future could depend on that capital amount. If the value of that investment were to go down, it could be catastrophic for the client’s future plans.
So, Capacity for Loss needs to be factored in as well as the risk attitude questions to make sure that we have considered everything carefully.
At what point do you discuss Attitude to Risk with clients?
It’s something we discuss very early on to set the tone for our recommendations. Nowadays, there are a combination of ways we can do the attitude questions – we can do this at our meeting or we can send them to you at home so that you have a good think about it. You can also complete them in an online portal.
There’s about a dozen questions to identify whether you agree, strongly, agree or disagree with certain ideas, and then an analysis looks at your responses. The main thing is to be honest in your answers, and don’t try to second guess anything.
How does attitude to risk affect how I invest?
There are hundreds of different types of investments and each will fit in different categories of attitude to risk. So your attitude helps us narrow down the sort of investments and funds to recommend.
Over a twelve month period or more, investments can change. It could be that your fund becomes riskier or less risky. So all investments need regular reanalysis to avoid taking unnecessary risks with your money. It’s something we actively manage. I speak to our clients every two months to review the situation and their funds’ gains and losses.
Do people’s attitudes to risk change?
Changes in life stages can impact very much on their attitude to risk. As you near retirement, for example, you won’t want to lose anything from your valuable pot of savings.
We might see an investor with a fairly relaxed attitude to risk, and the markets take a downturn. That client thought they would feel fine about it. But after twelve months they’re seeing a loss on their investment and feel uneasy. That would definitely be a time to reassess and look at that attitude to risk.
So things can change from a market point of view and things can change from a life stage point of view. And things can crop up in clients’ lives that we couldn’t plan and prepare for.
Is there a link between attitude to risk and access to your money?
Generally speaking, when we put together a portfolio for a client, if we need to make allowances for any early access, then we would factor that into the portfolio.
It’s not really attitude to risk that determines whether an investment is accessible or not. We could see an adventurous portfolio suddenly significantly growing overnight in value. There’s nothing to stop that client taking some of that growth out if they wish.
But really, we recommend that clients leave any investments for a minimum of five years, which is classed as medium term, but ideally you would leave them for an even longer term.
What difference does attitude to risk make to my investment growth?
Risk goes hand in hand with reward. So the less risky your investment, the more limited its potential for growth will be. Meanwhile, there’s potential for a risky investment to suddenly make you very wealthy overnight. But by the same token, you could also lose all your money, fast.
If you’re not taking financial advice, you still need to know your attitude to risk. Make sure that the investment that you’re going into is going to suit your attitude to risk because ultimately, the buck stops with you.