Whether by nature or circumstance, we all have different attitudes to risk. Risk aversion describes a type of conservative investor, one who values the preservation of capital over the potentially higher returns of a riskier investment strategy.
A risk-averse client will likely favour liquid assets, wanting their money to be available when they need it, without having to wait for favourable market conditions.
For a client close to retirement – one who has already built a considerable nest egg and is looking to consolidate their gains – this might be the right approach.
But for someone with years of potential investment growth left, the effects of risk aversion could be damaging.
Not only will a risk-averse client miss out on potential gains, but they could also see their invested amount lose value in real terms.
The damaging impact of inflation
Keeping money in cash is safe. Your client hasn’t invested their money; so, it has protection from the kind of volatility we saw in the stock markets at the beginning of the year.
Not only that, the Financial Services Compensation Scheme (FSCS), protects savings up to the value of £85,000 per person – £170,000 for a joint account – should a bank or building society fail.
To a risk-averse client, keeping cash could seem like the best choice. Until that is, you take inflation into account.
The Bank of England base rate currently stands at 0.1%. That means the value of your client’s savings is unlikely to keep up with the rising cost of living. Put another way, the value of your client’s savings will lose value in real terms.
Keeping some liquid assets aside – as a risk-free emergency fund – might make sense. But over the long term, a small amount of investment risk could mean the difference between your client maintaining and losing their wealth.
What is your client’s attitude to risk?
Your client’s attitude to risk will be personal to them. It will also take into account many factors, such as:
No one invests expecting to lose money. But for a risk-averse investor, their capacity for loss might be the most important thing to consider.
Understanding the impact that a large loss would have on your client’s lifestyle, now and in the future, is crucial. Would a large loss have a short-term impact, or would it mean making changes to their long-term financial plan?
No investor should ever invest capital they can’t afford to lose. Balancing this with an aversion to risk, whilst maintaining wealth in real terms, can be a tricky balancing act, but it’s one we can help with.
Understanding the desired end point of a particular investment can help a client to think about their capacity for loss and look objectively at their attitude to risk.
An investment made to help a young child onto the property ladder might be a short or medium-term investment. It will also be money that your client won’t want to lose and a low-risk strategy makes sense.
But, if the investment is for retirement, this long-term investment might allow slightly more risk.
This is especially true if your client has savings elsewhere – in a comparatively safe environment. Diversifying a risk profile across investments might allow your client to spread the investment risk, consolidating in one area to allow for more risks in another.
Generally, investing with a goal less than five years away isn’t a good idea. Short periods of stock market volatility can damage potential returns at the exact time your client needs the money. If your client hasn’t allowed sufficient time for the investment to recover, they could realise a loss.
Personal circumstances could inform your client’s attitude to risk. So could their nature.
The attitudes towards money we see growing up, for example, can have a massive impact on our attitude to financial risk in later life.
When your clients are investing, they need to feel happy with the decisions they make. Generally, that will mean staying within their risk profile.
How financial advice can help
Understanding a single investment decision within the context of a wider financial plan is a good place for your client to start, and we can help them with that. A diversified portfolio will spread investment risk and could allow greater risk in one area, with growth consolidated elsewhere.
We understand historic market performance and can use this knowledge to help your client see the generally upward trend of markets. When it comes to long-term investments, this could give them greater confidence.
By working with your client, we can get to know their attitude to risk and how their investments fit into their long-term plans.
With a diversified portfolio, aligned to their needs, we can spread investment risk, while mitigating the likelihood of their wealth losing value in real terms.
Get in touch
If you have clients that would like to discuss the role risk plays in their savings and investments, please get in touch with us. Email firstname.lastname@example.org or call 0116 2407070.
The value of investments can go down as well as up and might mean not getting back the full amount invested. Past performance is not a reliable indicator of future performance.
“At Boolers, you know that things will be dealt with properly and professionally. A real safe pair of hands!”
“I have always found the quality of advice, technical knowledge and level of service is second to none. ”
“Thank you to all of you for such a wonderfully smooth transaction! Hope we can do it again some time.”
“Boolers provided excellent advice when we needed it most.”
“Boolers have provided myself, family and business with pension and investment advice for over 30 years and continue to provide a high quality professional service to us all on an ongoing basis.”
“Chris Ball has been our Financial Adviser for many years and, from the start, we have been impressed with his strategic sense, his deep knowledge and his skills in helping us build our own successful retirement. He understands our aims and how to achieve them and has taken great care of us throughout. ”