Risk profiling is fraught with misunderstandings that lead to ill-advised approaches to determining investment suitability.
Risk tolerance reflects the level of risk which should be delivered for a client over the long term. Behavioural risk attitudes, in contrast, should not be mistaken for risk tolerance. They are not attitudes we should want in the driver’s seat for long-term portfolio optimisation. The role of suitability is to steer investors toward better outcomes, not replicate (and optimise for) all the silly things some clients often do.
For most investors, risk capacity is vastly more important than risk tolerance, and yet industry debate unnecessarily focuses on how to better measure the latter. Read full article here.
Risk capacity is vital because the risk investors are willing to take might not be risk they are able to take. Risk capacity chiefly concerns investors’ ability to meet future liabilities, so there is an essential connection between risk capacity and both:
(1) a holistic view of current circumstances and
(2) goal-based investing. Risk capacity is the vital pivot turning information from the wealth planning process into a measure of the appropriate risk level for the investment process.
If your IFA does not discuss these aspects with you may wish to review who you are entrusting your wealth management to.
So why is this important to your will review?
The two aspects of Financial Risk and the implicit risks within your will instructions are closely linked. A badly drafted will can devastate your whole lifetime’s wealth planning. Your will forms the cornerstone of your financial plan and strategy. For this reason, we normally expect to work with your financial planner to ensure compatibility. Contact us for more information; or just a chat!
Graham