That, coupled with the growing body of research on investment outcomes, should give advisers further discussion points with inherently very cautious clients on the risk/reward trade-off.
Risk and the advice process
So how does an adviser deal with the client who is too cautious for their own good?
A simple step might be to ensure your advice process is not primarily focused on investment risk.
If the process begins by you asking about the client’s tolerance to investment risk, this is likely to drive the shape and tone of the conversation, potentially closing down opportunities to explore beneficial alternatives.
The table below illustrates a more rounded approach.
Here the primary focus is on the client’s goals – what they want to achieve and when. This determines the investment return they need, which in turn determines how much investment risk they need to take to achieve that.
Only at this point does the adviser consider the client’s investment risk tolerance versus how much risk they need to take to achieve their financial goals.
If the client is not comfortable with the required level of risk then the adviser can take them through the options – for instance, save harder, work longer or reduce aspirations.
Alternatively, they may opt to take up risk just a notch, supported by a combination of these other options.
Source: Seven Investment Management
It might not be natural instinct to many investors, but in the vast majority of circumstances investors would be better off leaving more of their portfolios in equities at and into retirement than they have done traditionally.
That doesn’t mean investors should necessarily take more investment risk than they are comfortable with, but they need to understand that by choosing lower-risk investment options they may be increasing the danger of running out of money in retirement.
And they certainly shouldn’t do it automatically without thinking the issue through. This is something the FCA paper makes loud and clear, and it is very encouraging to see this creeping up the national agenda.
Ultimately, however, investment risk is not the only lever to pull when making investment decisions.
Investors should frame their plans in the context of balancing all the risks they face, not just investment risk.
This includes the risk they can’t save as much as they plan to, that they live longer than expected and that other events happen which knock their plan off course. This is something the FCA paper alludes to.
Advisers have a really important role to play in informing this debate, given this is one of the most important issues for the profession.
It will provide a great opportunity for clients to recognise the real value of planning and, above all, their adviser.
