With most investors seeking above average returns without risking their original investment it is important for advisers to lead their clients to the most appropriate products
If you can make one heap of all your Winnings
And risk it on one turn of pitch-&-toss
And lose and start again at your beginnings
And never breathe a word about your Loss Kipling, If
While very few savers would be prepared to risk everything on one investment, there are probably plenty out there who would empathise with not wanting to breathe a word about their recent losses.
Having said that, Kipling does help make a serious point about risk profiling; an advisor's responsibility to assess and agree each individual client's attitude to investment risk.
This is not as easy as it may seem. Ask anyone how prepared they are to take a risk with their money and they will usually say not at all, ask the same person if they want above average returns and they will say 'yes' without even recognising the paradox. Try the old poser of 'on a scale of 1 to 10 what is your attitude to risk?' and most people say '5'.
This is a difficult conundrum for advisers and increasingly they are relying upon narrative approaches to risk profiling to get the most meaningful results. This involves describing typical investment scenarios to clients and asking them for their reactions.
For example, if due to stock market falls the value of your investment was suddenly reduced by 20%, would you a) surrender and cut your losses, b) do nothing and wait for a recovery or c) identify a buying opportunity and invest more?
A client who chooses option b) could be defined as 'realistic investor' on the understanding that they would like to ensure their short term financial security through low risk investment but also wish to benefit from long term investment returns. The reference to short and long term is also indicative of the difference that time can make to a client's risk attitude. Someone who has more time to invest over, say 10 years or more, is in a position to accept an otherwise higher level of volatility, and therefore risk, than an investor with only a short time frame or a specific date at which the investment must be realised.
Similarly, a client who demonstrates a relatively cautious attitude has to be made aware of the inflation risk they are running, that the buying-power of their capital will reduce over time. Cautious investors are usually bracketed with deposit-based investments, such as bank and building society savings accounts and, depending on their tax status, ought probably to consider cash mini-Isa's, where gross interest rates of up to 4.5% are available, although these may be subject to notice. National Savings, fixed interest and gilt orientated funds could also be considered appropriate
The amount of money available for investment may also affect an investor's risk attitude. Those with more to invest often have a more balanced approach and can adopt a range of risk levels across the whole portfolio. In addition to taking up their annual Isa allowance (up to £7,000), this type of investor may benefit from a collection of with-profit and managed bonds, which may include a 'guaranteed' element in relation to either the return of capital or the growth rate.
Another possibility is to invest in a basket of traded endowment policies that have known guaranteed minimum sums assured and known maturity dates. The requirement to maintain the regular premiums can also be easily managed by taking advantage of a gearing facility that effectively loans the investor the outstanding premiums and rolls-up the interest against the ultimate maturity values.
This type of 'realistic' investment might be aiming for annualised returns of in excess of those available from deposit based investments averaged over the next three to five years, which, in current markets, may represent a fairly reasonable expectation.
A more sophisticated investor, with sufficient funds, could consider taking advantage of the new covered warrants. Similar to traded options, covered warrants give you the right to buy or sell an underlying stock or market at a particular price, up to a specified date. In this way they can 'hedge' their investments, for example by using 'put' (sell) warrants to protect against falling markets.
It must be remembered though that the 'risk' with any warrant is losing the whole of their investment in that product. But they may be willing to contemplate this where they are using the warrant as insurance against an adverse movement in a larger portfolio. This is known as 'hedging' and is long-established method for managing risk.
An investor with this kind of outlook could also look at investing in more specialised areas such as currencies and gold. However this would probably be through a managed fund as opposed to directly in the underlying asset as, by spreading the investment and employing professional management, risk is again reduced.
Remember though that these remain very volatile commodities and an investor has to be prepared for sudden movements. For someone prepared to accept this increased level of risk, the aim would be to achieve higher returns than those sought by the 'realistic' investor mentioned above, although they have to be ready for some pretty rocky rides along the way and it is definitely not for the faint hearted.
However, few clients are either this fortunate or this speculative and, generally speaking, the crucial role of a professional advisor is to manage the client's realistic expectations by explaining fully, and in a manner that is easily understood, all of the implications of any proposed course of action.
David Holbrook, managing director of Hallmark-ifa
‘Important to have an anchor’
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