Understanding Attitude to Risk and how it affects an individual’s investment portfolio.
When it comes to making investment recommendations to a client, it is essential we ‘know our customer’. Not only is this within our regulated requirements as set by the FCA. It ensures our clients all receive the best investment advice suited to them. Which in turn, leads to a happier client in receipt of the investment portfolio that is suited to them, their needs and their attitude to risk.
The ‘Knowing Your Customer’ guidelines and regulations as issued by the FCA (The regulatory authority that regulates the financial services industry), published online back in 2015, are set in place to ensure Financial Advisers have obtained all the necessary information required to make a true, accurate recommendation to a client. Although every detail set out withing the guidelines may not be essential to every financial recommendation, consideration must be shown to areas such as:
- Financial Situations
- Investment Objectives
- Knowledge and Experience
- Impact of Advice
The guidelines also sets out that consideration should be shown to:
- The areas of advice/need.
- The risk profile of a client.
- Changes in circumstances.
The considerations made from the above areas will all contribute in calculating a client’s attitude to risk.
What is Attitude to Risk?
A clients attitude to risk is the risk they are comfortable and prepared to take with their money and investments. A Financial Adviser will, prior to offering any investment advice, conduct a questionnaire or application to determine a clients attitude to risk. This will venture in to the bullet points as mentioned above.
Often risk tolerance is a predisposed trait. Attitude to risk will generally remain quite stable over a clients lifetime. There may be times when clients become less averse to risk or quite the opposite. There is no problem with this, although, any thoughts or changes which may affect appetite for risk should be mentioned to a Financial Adviser.
Attitude to risk should not be confused with attitude to adventure. It is quite understandable to believe that these two traits would reflect each other. Conversely, often those with a strong sense of adventure wish to manage their finances much more cautiously.
Calculating Attitude to Risk
A Financial Adviser will have a method to calculate attitude to risk. Every question they ask will be relevant in establishing attitude to risk, even if the detail seems insignificant. A Financial Adviser will share the results of this, and they will explain how this has affected any advice that will be or has been offered.
There are online questionnaires available for individuals to determine their attitude to risk. With benefits including easy to access, convenient and receiving results quickly. These online questionnaires do have a number of drawbacks. Online questionnaires are pre-set and static, there is no allowance to dictate variations in answers. Additionally, they do not look at the bigger picture which is what a Financial Adviser will do.
An Appetite for Risk
Those who are less risk averse, and have a higher appetite for risk could potentially receive greater gains out of their investments. Equally however, combined with higher risk investments is more market volatility. Consequently, this could lead to losses in their investment.
Those who are more risk averse, and have a lower appetite for risk are still able to receive gains from their investments. This comes alongside the benefit of less market volatility.
As mentioned above, attitude to risk is generally quite stable as a result of being a predisposed trait. Often clients may experience short term increase in their attitude to risk. This could be a result of seeing changes in the financial markets, seeing positive trends in their current investment portfolio or being in receipt of a larger sum of money. Financial Advisers will recognise these changes and make changes to investments accordingly, however it must be noted, an Adviser may advise against this initially based on a previous attitude to risk.
Overall, attitude to risk will contribute an extremely important share to how a clients finances are invested within their investment portfolio. Their attitude will directly impact the report created by a Financial Adviser, however this is something that is discussed in detail ahead of a client going ahead with any recommendations.
If you would like further guidance on the risks and rewards of a financial investment and how you could benefit from this. Visit the Contact Us page and talk to The Harvest Partnership Ltd. We always recommend you seek professional advice ahead of committing to any investment strategy.