As a follow up to an article I wrote earlier on this week, I though it deemed fit to discuss one of the critical aspects which needs to be considered when providing financial advice, and that is the perception investors have on risk.

Are investment advisors able to comprehend, and even more importantly, quantify this? What are the key factors and circumstances which make up a client’s tolerance of risk? What should financial advisors seek from the client in order to be able to be in a situation whereby his/her his explanation of risk is commensurate with and meets the client’s risk tolerance? What is the client’s comfort zone and what is his maximum loss capacity, both from a financial and emotional viewpoint?

Besides the market factors, historical stats and current environment analysis that surely help a financial advisor in selecting suitable financial instruments for a client, what other vital information should the advisor pickup from the client conversation(s) in order to be able to assess the client’s risk appetite and be in a position to build portfolios for individual retail clients?

Clearly, there is no off-the shelf solution to this, and this exercise needs to be tailor made in a holistic manner. We cannot place clients in pigeon holes and label them. They need to be given the service they deserve, suitable for their needs and circumstance. This is an individual bias which is mainly formed and aligned with direct previous investment experience and other influences from friends and family members, and the client’s investment education and understanding. Personal character and emotional traits including how well investors can handle stress are also important factors which should be given their due consideration.

So how do we explain risk and ensure this is correctly understood? For starters, a thorough understanding of the individual client is needed and an assessment of the individual circumstances. This is where proper client fact finding plays a key role in risk assessment.

Besides basic information such as age, profession, marital status, dependents etc. - which will determine at which stage in life the client is and also the time frame available for investment - the analysis needs to dig deeper into clients’ understanding of investments and how this is being interpreted. Why is the client looking to invest his hard earned cash? What does s/he expect out of this investment? Are the expectations realistic or unachievable, and if not, are they being made aware? Does the overall personal financial situation allow for fluctuations in capital invested and, even more, does the client have the capacity to take losses on the amount invested?

By moving away from a tick box approach, the above analysis will give factual insight about the client. The information gathered will define the level and depth of market and investment information/education required for that particular client to truly understand any investment proposal. An investment proposal is as good as the fact finding exercise that was undertaken with the respective client. If the fact finding is done correctly, then the client is sure to be steered in the right direction by going for investment solutions designed to their investment objectives, match their risk profiles, affordability and acceptance for financial loss and last but not least an investment proposal which is easily understood and accepted by the client.

It is hard and cumbersome to draw a correct picture of the client without asking the appropriate questions required for accurate assessment and it is also hard to isolate different sections of the fact finding. Personal information, a client’s overall financial situation, understanding and knowledge of investments and investment products, previous and current transactions together with the investment objectives all form key parts in creating a personalised investment proposal.

This is why clients need to be informed that it is important to collaborate and disclose personal information to their respective financial advisor, who is relying on that information to provide suitable advice. This is the precise approach we as investment managers use when speaking to high-net worth individuals and corporations, in the forms of our Discretionary Portfolio Management proposal. It is by doing so that we can ensure that all risks being undertaken are aligned with the client’s perception of and ability to take on risk.

Disclaimer:

This article was issued by Mark Vella, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.