Risk profiling has become much more sophisticated in recent years and plays a crucial role in achieving optimal investment outcomes for clients.
Prior to the advent of the Financial Services Advisory and Intermediary Services (FAIS) Act, risk profiling and a systematic investment approach were not regulatory requirements. Asset managers created funds which were then sold to investors. Clients themselves, on a whim, also asked to buy a specific product or asset class that had received rave reviews in the press.
Any risk assessment that was carried out was inclined to focus merely on how a client felt about risk by asking a few subjective questions about your emotional and psychological response to risk. This is akin to asking you how you feel about playing blackjack for high stakes!
Modern day risk profiling takes on a much more holistic approach. It quantifies three distinct aspects of risk and makes the additional provision of including a time horizon.
The first aspect, Risk tolerance is a subjective characteristic relating to the emotional or psychological aspect of risk. It describes the extent to which a person is ‘willing’ to accept risk and the possibility of suffering financial loss for a possible higher investment gain. Risk tolerance differs from person to person, and it may also vary during the lifetime of an individual depending on age, family scenario, income and financial goals. Risk capacity looks at the extent to which an investor’s financial position is strong enough to withstand certain negative events without entirely derailing their important investment goals. Investors with larger portfolios are more likely to have the capacity to take on greater investment risk and volatility. Risk required refers to the level of risk that needs to be applied in the selection of financial products to achieve the rate of return required to meet the client’s investment goals from available financial resources.
It is the skill of the expert financial advisor to assess these three elements of risk and incorporate the respective time horizon to customise investment strategies suited to each investment scenario.
Time horizon is another important component of holistic investment risk management. It is critical to remember that not all of your investments will have the same risk profile, nor will your risk profile remain constant for the duration of your lifetime. Investing towards your retirement over a period of 30 years will have quite a different risk profile from a five-year savings plan to fund your adolescent’s university education. The differential in the range of expected returns of investments such as equities (shares on the stock exchange) reduces the longer the investment term. In other words, for an investor with a short time horizon, equities could prove to be highly volatile and therefore risky, but over a 20-year period, the same investment would be far less risky.
Download the Rutherford Risk Profiler and check your risk profile for yourself. Remember different investments will have different risk profiles according to their respective time frames. This is an important step in empowering yourself on your financial journey.
The more informed you are when speaking to your financial advisor, the more likely you are to achieve success in all aspects of your personal wealth creation.
Submitted May 15, 2017 at 09:34AM by Rutherford_Capital http://ift.tt/2qnvgvv
