We all have a different appetite for risk in investment just as we do in life. It’s a matter of personality, circumstances and goals. Some of us like to play it safe. Some believe that nothing is gained if nothing is ventured, even on a rainy day.
Getting risk right is one of the most important areas where a financial adviser can help. It needs work to perfect and everyone has a different approach.
Advisers will work with you to identify your risk appetite and then map it against the investments available. It will probably involve some form of risk rating.
Each will have his or her own way of doing this, though some may use software that has been developed by a third party.
How it’s done
Financial planner Ivan Lyons, from sunny Worthing in West Sussex, explains. “Clients complete our Risk Profiling Questionnaire to establish their level of risk and capacity for loss. Essentially, each client is scored between one and 10, with one being the lowest level of risk. This will determine the asset allocation of funds.
“The portfolio is benchmarked against the client’s tolerance to investment risk on an ongoing basis.”
This is the essence of risk rating. While a cautious client will be happy with shares in Very Sensible plc and accept the accompanying low returns, another will want to invest in Billionaire Or Bust Inc (Grand Cayman).
It’s risky not knowing about risk
Mark Insley, of Ascot Wealth Management, explains risk ratings at the first meeting. “I always think a client should be fully informed of any risk that they take, be it high or low risk investments,” he says. “We wouldn't want a low-risk investor to be invested in a high-risk portfolio as they wouldn't be comfortable with it all.”
Volatility is key
Financial advisers and fund experts use their own systems of ratings to assess a client’s aversion to risk. In the light of their findings, they can build a portfolio to match.
Risk-rating tools differ and tend to be proprietary. But all assess how volatile an investment is likely to be (how much it swings up and down) – and how much it might return for an investor over a given time. Greater volatility could mean big rises, but could also result in big falls.
In general terms, cash is the least volatile, while equities in emerging markets are among the most volatile.
While all risk-rating systems are different, they give a good indication of your attitude to allow your adviser to build the most suitable portfolio for your needs.
So when you speak to an adviser for the first time, be prepared to be quizzed on your rainy day apparel! Find out more about what to expect from your first adviser meeting.