Let’s take a look at these elements and see what can be done to minimise the risk of risk drift.
Most advisers now use some form of risk profiling tool with a psychometric questionnaire at its heart.
The client is asked a series of questions designed to assess their attitude to risk.
The result is that the client will find themselves at a point on a risk scale. Perhaps one to seven, or one to 10, depending on which tool is used.
Academics suggest that a person’s attitude to risk will never change, it is a fixed part of their personality. This is sometimes called natural risk.
So, we have the client's ‘natural’ risk score. At this point the adviser and client need to discuss this outcome and see if it works for the client in the real world.
The first consideration is the client’s capacity for loss. This means taking into account the client’s ability to absorb falls in the value of their investment.
In other words, how much can the client afford to miss their goals by?
In practice, this may mean moving a client down the risk scale from their natural score to a more comfortable position, or potentially, a more difficult discussion suggesting either taking a little more risk than is indicated by their natural risk score or being a bit more realistic in their goals.
Clearly capacity for loss is an element of the client risk profile that can change over time.
Inheritance, windfalls and significant salary increases are all likely to increase a client’s capacity for loss. A sudden hit on savings or long-term unemployment are likely to have the opposite effect.
Changes in circumstances such as these are a signal for the adviser to review the client’s investment choices.
In some circumstances it may mean the adviser can bring the client more in line with their natural risk score. In others it may be a case of having serious discussions with the client around scaling down their goals, increasing savings or taking on more risk.
All these elements should be examined at least annually, so adjustments can be made along the investment journey if necessary. Basically, dialling the client's risk profile up and down as fortunes dictate.
Comparing apples with pears
So, let’s take a look at the other side of the equation.
Having established a workable risk profile score for the client, the adviser will look for a suitable investment that will take a level of risk that the client is comfortable with.
