Understanding your goals and your attitude to investment risk is the foundation of giving suitable advice. Before we can make recommendations on pensions, ISAs or investment portfolios, we must establish your objectives and the level of risk appropriate for your circumstances.
We will explain how we, as an Independent Financial Adviser (IFA), identify client objectives and assess your risk tolerance, and why this process is essential to building your long-term financial plan.
Why identifying client objectives comes first
When you first engage with us, you can expect conversations about:
- Your long-term goals
- Your short-term goals
- Your desired retirement lifestyle
- Your timeframes
Having clear financial objectives helps your adviser to determine what level of return may be required and whether your goals are realistic.
READ WHAT TO EXPECT WHEN YOU FIRST ENGAGE A FINANCIAL ADVISER
Turning retirement into a clear financial plan
Many of our clients started their journey with one goal in mind - retiring early. However, effective retirement planning requires a much deeper understanding of you and your circumstances. Things to consider include:
- How much annual income will you need?
- Do you plan on changing your current lifestyle?
- Will you travel?
- Do you plan to downsize?
- Do you want to leave a legacy?
- How flexible is your retirement age?
Financial planning firms use structured discussions and specialist software, e.g. cashflow modelling, to turn broad ambitions into measurable financial targets.
Remember: the earlier you start your retirement planning the better.
This is just one example of a goal our clients have in mind when they first engage with us, but it does give an insight into how much deeper the conversation needs to go as opposed to just having an end goal in mind.
How financial advisers assess risk tolerance
One we have defined your objectives, the next step is assessing your risk tolerance.
Risk profiling is not simply about labelling someone as “low”, “medium: or “high” risk. It involves understanding three distinct areas.
1. Attitude to risk
An “attitude to risk” assessment measure your emotional comfort with investment volatility.
Most firms use a risk tolerance questionnaire, which is then processed through specialist software to explore how you might react to:
- Market falls
- Investment losses
- Short-term fluctuations
- Market uncertainty
Whilst the questionnaire gives some insight into your risk tolerance, your adviser will discuss the results in detail to ensure they accurately reflect your mindset.
2. Capacity for loss
Capacity for loss is different from attitude for risk. Whilst your attitude to risk is based on your emotions, capacity for loss assesses your financial resilience.
The capacity for loss assessment may ask questions such as: “if your investments fell in value, how would that impact your lifestyle?”. This scenario will impact each person differently, for example, a retiree drawing income will be impacted more than someone that is still in paid employment and building their assets.
When creating your cashflow model, part of the assessment will be to stress test against various scenarios and market crashes to help determine your capacity for loss.
Even if you feel comfortable with risk, your current financial position must support that level of exposure.
3. Time horizon
Your investment timeframe significantly affects the level of investment risk that may be suitable.
Historically, markets fluctuate in the short term but can deliver growth in excess of inflation over longer time periods. A longer time horizon may allow for a greater tolerance of volatility, although risk can never be eliminated entirely. This is why we advise you to have an investment strategy of at least 5 years.
Aligning objectives with risk profile
This is where we will build your financial planning strategy.
Your objectives determine:
- The level of return required
- The timeframe available
- The importance of the goal
Your risk profile determines:
- The level of investment volatility that is appropriate
- The asset allocation within your portfolio
- The structure of your financial plan
If there is a mismatch, e.g. you require high returns to meet your retirement objective, but you have low risk tolerance then your adviser can explore other options. Alternative solutions such as adjusting your expectations, increasing your savings, extending your timeframe or reprioritising your goals will be discussed with you, to ensure your financial plan remains realistic, achievable and suitable.
What you can expect from henson crisp
When you work with us you can expect in-depth discussions about your financial goals. This will help us ensure we recommend the right products and services for your personal financial situation.
Our risk tolerance questionnaire will help us provide you with a clear explanation of your risk profile; alongside this, we will consider your capacity for loss to help develop a suitable investment strategy.
READ ABOUT HOW WE ASSESS THE SUITABILITY OF FINANCIAL ADVICE
Building your financial plan around you
Identifying client objectives and assessing risk tolerance are not just administrative steps. When done properly, these steps will help us build a solid financial plan, reflecting what matters most to you, what is financially achievable and what level of investment risk is appropriate for you.
RISK WARNING:
The value of investments can go down as well as up. You may get back less than you invest. Past performance is not a reliable indicator of future performance.
Investments are subject to market fluctuations. Short-term losses can occur, and investment values may fall significantly during periods of market volatility.
It is important to ensure that you can withstand potential losses without materially affecting your standard of living or long-term financial security.
Financial projections and cashflow models are based on assumptions and are not guarantees of future performance.