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Danby Bloch: Squaring client expectations and risk

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The question: The Smith Jones Financial Planning risk committee was discussing investment and risk profiling – again. It had covered the broad strategy at its previous meeting and now wanted to look at understanding clients’ aims and expectations and how these would relate to the level of risk clients would need to take to achieve them.

The solution: This concept of the level of risk is different from that of risk tolerance, which covers how they feel about taking investment risk. 

It is also different from risk capacity or how much risk they can afford to take. Of course, all three aspects of risk are related to each other.

The most common situation that clients need to deal with in this context is retirement so the Smith Jones risk committee decided to focus on this area. 

The first question it tackled was how to help a client think about retirement in a sufficiently realistic way and then turn their thoughts into the financial numbers that will form the basis for planning.

Using long-term cashflow modelling

It is obvious that the key planning tool is long-term cashflow modelling. The risk committee has decided that its use should be mandatory across the company as part of the financial planning process for most clients.

Generally, people aim to achieve a standard of living in retirement that is roughly equivalent to what they have enjoyed in their final years in work. 

There will need to be some adjustments – probably no mortgage, fewer formal clothes, little or no commuting and rather more holiday and leisure pursuits or hanging out with the grandchildren. That would be the ideal.

The most senior adviser in the firm reminded the risk committee of the paradox of financial planning: the nearer you are to the moment for which you are preparing – in this case, retirement – the easier it is to take the process seriously and envisage your goals but the harder it is to change the situation by saving more or altering the investment strategy.

The further away the expected retirement date, the harder it is for clients to think about their future standard of living once they have stopped work so the lower the priority they tend to give retirement.

One way to prompt younger clients to think about their retirement is to look for a role model among their older relatives or friends who has achieved a desirable standard of living post-work.

Fortunately, long-term plans do not have to be too precise – and they cannot be. 

Taxbriefs Advantage has some very helpful guidance on retirement planning and risk, which fed into the committee’s discussions.

Matching resources to desires

Once it is reasonably clear what the client is aiming to achieve, the adviser needs to quantify the client’s resources. That will help to define the risks they will need to take and whether they may have to redefine what they want.

Some fortunate clients have a healthy enough pensions and investments portfolio to be able to retire comfortably. 

In such cases, the client should typically be able to take little or no risk with their money.

Presented with this news, they may then want to reappraise the situation and reconsider their aims. 

They may want to consider inheritance tax planning for the family or perhaps a rather more ambitious standard of living for themselves. 

Or they may simply choose the really low-risk investment option.

Other clients may have a shortfall between their aspirations and their resources. They then have a choice: they can either readjust their goals and accept that they will have a lower standard of living in retirement or they can consider taking on higher investment risk to achieve their goals. 

Further options would be to save more or retire later. The chances are that such clients will choose a mix.

The trickiest course of action is to agree to take on more investment risk. The shorter the timescale, the more hazardous and less effective it will be to take the riskier road, which is why so many clients opt for taking on more risk combined with postponing their retirement.

Building in alternatives

Whichever way a client chooses, the most senior adviser at Smith Jones urged the risk committee to recommend advisers to ask their clients about a plan B for retirement. And the riskier the strategy, the more important it is to consider this alternative scenario.

Quite simply, the adviser needs to ask: what would you do if everything went pear-shaped and you had to live with a substantial shortfall?

Taking a more risky investment approach carries an implication that the strategy may not succeed or may not succeed in the timescale envisaged. With the help of an alternative scenario from the long-term cashflow projection, clients have the opportunity to consider living on a lower-than-ideal level of income, working rather longer, selling or maybe mortgaging their property or perhaps a mix of all these possibilities.

The fact is that the future remains one of the most difficult things to predict. And one way to cope with the uncertainties is to plan for various scenarios rather than relying on a single plan from which one could never deviate. 

As General Dwight Eisenhower once said in a moment of hyperbole: “Plans are a waste of time but planning is essential.”

Danby Bloch is editorial director of Taxbriefs Financial Publishing

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