View more on these topics

Chris Gilchrist: Don’t ask clients what they can afford to lose

Chris-Gilchrist-MM-Peach-700.jpg

In my last column I said that ‘How much can you afford to lose?’ ought to be the starting point of a process to deliver investment recommendations.

Several readers have pointed out that the client cannot answer this question. I agree: it’s a question the adviser has to answer, because capacity for loss is a professional judgement, not a fact.

I do not see this as a problem. On the contrary, it is where advisers’ value lies in the investment process – their ability to interpret circumstances, goals and attitudes to deliver a satisfactory investment outcome.

I have seen risk questionnaires where, after a set of attitudinal questions, there is a question along the lines of ‘What is the maximum percentage you could afford to lose?’ which is taken as the ultimate determinant of risk profile and asset allocation. This is nonsense.

If you ask the client, you get an uninformed attitudinal answer, because the vast majority of clients cannot relate a loss to their circumstances in such a way as to understand the consequences.

An attitudinal questionnaire may deliver a reliable output in terms of a personality profile. But it is not predictive. I am a calm and tolerant person, but this does not predict my response to any specific occasion on which someone is chattering loudly on their phone in the quiet carriage.

Someone with an apparently high tolerance of volatility may respond with irrational panic to a crash simply because of the coincidence of personal and other circumstances. A generic prediction that in nine out of 10 crashes an investment client will be calm and rational is not one I find useful.

Assessing capacity for loss is an analytic exercise. It requires the adviser to know about a set of important circumstances for the client. Usually, some enable the client to withstand losses while others make them more vulnerable.

Many advisers probably run heuristics along the lines of ‘good health > greater capacity, poor health > lesser capacity’, ‘secure income > greater capacity, insecure income > lesser capacity’, ’large expectations of capital > greater capacity’ and so forth.

In my view, it is impossible to construct a questionnaire that captures all possible relevant circumstances and weights them to give an overall assessment of capacity. There are too many circumstances and they interact in too many ways.

However, you can construct a questionnaire like Harbour, which includes questions that affect capacity for all clients – for example, the amount of capital held outside the proposed investments, the percentage of total income that will be derived from investments, and liquidity/access requirements. An adviser can use this to set an appropriate asset allocation.

Since the main problem with capacity is that advisers often deal with it differently, constructing a questionnaire where scoring delivers an indicative output in terms of asset allocation is an essential control tool for owners of adviser firms. There should be clear documentation of the reasons for deviation from this – identifying which circumstances are relevant and why.

If all this is ‘played back’ to the client, they should have clear understanding of why the recommended solution is suitable. And the adviser firm should have solid records to justify its advice at any point in time, provided of course that client assessments are regularly reviewed.

Chris Gilchrist is director of Fiveways Financial Planning, a contributing author to Taxbriefs Advantage and edits The IRS Report

Recommended

3

Tom Baigrie: Change is being obstructed by vested interests

In protection, we all agree we need to simplify our application processes for intermediaries and consumers alike and that the best way to do that is to ensure the quote given is the real one, not one just for the perfectly healthy. We now believe consumers are happy enough to answer questions if those questions […]

4

Mel Kenny: The D2C advice robots have arrived

Well, if they are not staring you in the face already, let me tell you this – the robots have arrived. Like something out of Dr Who, D2C or B2B2C are here to stay  and no matter how uncomfortable you feel about having them in your living room, you are going to have to accommodate […]

Mackay-Holly-peach-NEW.jpg

Holly Mackay: Seven wonders of the fin tech world

It is pretty obvious to anyone with one functioning retina that UK retail financial services brands have not focussed on the interface with their customers, whether that is online or in print.  Most client reports are horrible. Life companies are particularly good at sending out 18 pages of black and white boring twaddle but newer […]

barclays-building-2012-700x450.jpg
6

Inaccurate FCA returns and account names: Why Barclays was fined £38m

Barclays submitted inaccurate returns to the regulator and mixed client money with other assets, the FCA’s final notice reveals. Earlier today Barclays was fined £38m by the FCA for failing to properly protect £16.5bn of clients’ assets. The regulator found “significant weaknesses” in the systems and controls of the bank’s investment banking division between 2007 […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

There are 2 comments at the moment, we would love to hear your opinion too.

  1. And still Mr Gilchrist seems to be under the impression that the sun shines out of his oratory. This is a subject that can be discussed, debated and theorised upon ad infinitum. Most of us, I suspect, just get on with constructing, monitoring and reviewing suitably diversified and balanced portfolios that, over the medium to long term, can be relied upon to do what’s hoped of them. There are no magic recipes.

  2. If it falls to the adviser to answer the questions around their client’s capacity for loss then doesn’t it also fall to the adviser to answer the questions around how much investment risk should their client take?

Leave a comment

Close

Why register with Money Marketing ?

Providing trusted insight for professional advisers.  Since 1985 Money Marketing has helped promote and analyse the financial adviser community in the UK and continues to be the trusted industry brand for independent insight and advice.

News & analysis delivered directly to your inbox
Register today to receive our range of news alerts including daily and weekly briefings

Money Marketing Events
Be the first to hear about our industry leading conferences, awards, roundtables and more.

Research and insight
Take part in and see the results of Money Marketing's flagship investigations into industry trends.

Have your say
Only registered users can post comments. As the voice of the adviser community, our content generates robust debate. Sign up today and make your voice heard.

Register now

Having problems?

Contact us on +44 (0)20 7292 3712

Lines are open Monday to Friday 9:00am -5.00pm

Email: customerservices@moneymarketing.com