Investing is inevitably an emotional endeavour. Unless schooled in the principles of behavioural finance, most investors will at certain points unwittingly undermine portfolio returns through actions that make no rational sense albeit make perfect emotional sense.
Our goal as an adviser is to improve upon the return shortfall that investors generally experience, by means of a disciplined and structured approach to investing, which includes the following steps:
Academics define investment “risk” as the volatility of returns, i.e. the extent to which the returns tend to fluctuate. The more volatile an asset the more in terms of a return we require to invest in it. The volatility number is simply an expression of the uncertainty about the size of changes in a funds value; Higher volatility – values can potentially be spread out over a larger range of values. Low volatility – value does not fluctuate dramatically.
Clients’ perception of risk and what the financial services industry considers to be risk can differ entirely. This can lead to confusion if we were to rely solely on quantitative measures of risk, such as volatility.
Clients in our experience do not think of risk in terms of narrow mathematical terms. Clients are primarily concerned about a loss of capital or paltry returns, not necessarily price fluctuation. Clearly, we cannot ignore the volatility of returns, but risk preferences need to be assessed under a broader canvas than one which focuses mainly on volatility.
Given the afore-mentioned problems with measuring risk, where does Global Life & Finance Ltd start? Just as risk is not a single number, neither is a client’s risk profile. This is difficult to measure accurately. Our approach to risk profiling is to ask the client to fill out our risk questionnaire. The questionnaire should only provide a starting point for a conversation about investment risk, not an ending. We use the output of this tool to form the basis of a broad discussion on risk.
All clients of Global Life & Finance Ltd are required to read the appendix on explanation of investment risk.
A client’s psychological willingness to take risk can sometimes clash with their financial ability to do so. For example, a client might express a preference for risk which is low, but have a financial situation which indicates a risk capacity which is higher. When such a conflict exists, we need to take time to counsel the client and explain the consequences of the mismatch. We explain the consequences of low returns to more conservative investors with liquid wealth and vice versa.
Ultimately, a client might insist on an investment strategy that matches their risk attitude and we may need to accept this. But having had the conversation, the client/adviser decision will at least be in the context of a thorough review of the investor’s risk capacity, attitude and need.
A client’s ‘willingness’ to take risk, as measured by a questionnaire for example, is only a small part of a client’s full and true risk profile.
Three key components comprise an individual’s true risk profile:
As part of our Investment advice process we assess the client’s attitude to risk and capacity to suffer loss. One of the tools we use to help us in assessing attitude to risk is our risk profile questionnaire. As mentioned above the questionnaire encourages and promotes discussion around risk.
It is also important that our client’s expectations are aligned with their risk profile. We consider this part of our discussions as one of the key points in the process. If the client’s expectations are not aligned with their risk profile, this can lead to inevitable disappointment and confusion. Through concrete and honest conversation around the risk questionnaire our clients make confident investment decisions that are informed and sound. It also avoids our clients making irrational or emotional decisions further down the road regarding their portfolios.
Risk Profile Questionnaire
Global Life & Finance Ltd is regulated by the Central Bank of Ireland.
Global Life & Finance Limited – Reg in Ireland No. 323964
Reg. Office: Brook House, Unit C4, Donnybrook Commercial Centre, Douglas,
