Risky Business
Risky Business
10 November 2020
What is meant by attitude to risk?
A quick Google search for the definition of “risk” offers many descriptions. None of them are very pleasant. “The possibility of something bad happening”, “Possibility of loss or injury”, “the degree of probability of loss”...and so forth. A word with such negative connotations is bound to inject an element of anxiety when relating it to your financial planning. Likewise, when we turn to reference material for advisors, we are taught that attitude to risk is “The maximum level of uncertainty an individual is willing to tolerate in exchange for incremental units of return.”*
We’re not disputing this definition, however, our thoughts are that perhaps risk itself shouldn’t be looked at as something quite so negative, and instead something that, as financial planners, we help you embrace.
Risk concerning money is often confused with the value of investments rising and falling during short periods. We expect ups and downs and factor volatility when preparing financial plans. The real risk lies in not reaching your milestones and life goals.
Human behaviour is another key risk that can knock you off track if not managed well. For example, how you respond to a perceived loss when investments fall. The 2008/9 stock markets crash resulted in a fall of around 50% but, by the end of 2010, the markets had returned to previous highs. People who responded by selling their investments will have struggled ever since to have recovered from their loss. Not knowing when to reinvest results in losing out on returns as the markets rise, leading to a double whammy.
when is attitude towards risk measured?
Your attitude to risk is measured during the onboarding stage via a set of industry-set multiple choice questions. It might be worth re-evaluating your attitude to risk as you experience changes in your lifestyle, goals and financial situation. the traditional thought process is that a2r reduces as we get older. However, we have found that in some cases, as people accumulate experience through personal and global events, they become more tolerant towards risk. Eg. ‘Sam’ who lived through both Gulf Wars, the ‘Millennium Bug’ and the 2008 financial crash may have developed a higher tolerance than 20 yo Charlie entering the workforce in 2019.
Whilst the answers you give help inform us about your behaviour towards investing, we will always adjust your investment portfolio to ensure you feel comfortable with the risk you are taking, and so we view the questions as a springboard to further in-depth discussions about how you may be feeling.
closing thought - attitude towards risk = attitude towards volatility
When it comes to investing, we can’t predict how the stock market will behave. The media reports on stock market rises and falls and we don’t believe we’ve ever seen a headline indicating “the stock market is behaving normally.” The rise and falls are the norm. There will always be volatility, however, if you want to achieve your goals, we suggest embracing this volatility. If you have a comfortable relationship with your financial advisor, and trust what they say, you’ll be able to weigh out the peaks and troughs knowing that the long-term gain will outweigh the short-term volatility.
Sources:
*https://www.cfainstitute.org/-/media/documents/survey/investment-risk-profiling.ashx