Do you know the risk in your investment portfolio?

28 November 2018

Who amongst us would buy a ‘warm’ holiday from a tour operator without knowing whether the destination was Dublin or Dubai?

Or perhaps something ‘nippy’ from the car dealership which you only knew would be faster than a Prius but slower than a Porsche? It is alarming to us that some (not Old Mill clients, may I add!) are investing for their future on a similar basis.

Vague labels can be problematic and this issue has been highlighted for scrutiny by the Financial Conduct Authority (FCA), as well as being cited by the Financial Ombudsman as a common subject of complaints.

In a recent study the FCA found that investment portfolios from different managers labelled as medium or balanced risk could hold anywhere from 20% – 75% in stocks, surely a range too wide to have any use at all.

Clients identifying as ‘Cautious’ typically prioritise security of capital and are often approaching retirement or already retired. But the same study found portfolios labelled as low risk could have exposure of up to 60% in stocks, likely meaning losses of up to or in excess of 25% in a stock market fall. In these circumstances, for a hypothetical £400,000 portfolio to lose more than £100,000 could certainly cause surprise and dismay and I certainly would not feel comfortable putting a client in that position. Yet that is exactly the impact of such subjective and misleading descriptions, still in popular usage by some investment managers.

Of course, the challenge here is that every person will have their own definition of what they understand by ‘Cautious’ or ‘Balanced’ and for this reason there really is no substitute for a truly direct conversation about what rate of growth you feel is needed and balancing this with how much money you are likely to lose in this portfolio when a bad year comes around.

Whilst we cannot forecast when markets are likely to fall or rise or the magnitude of these, we are able to look back to what a ‘worst case scenario’ in the past has been for different portfolios. We can back-test portfolios through the dark days seen by markets in living memory; do you remember such lowlights as the Financial Crisis of 2007, the 3 Day-Week of 1973 and Black Monday, October 1987?

We will be led by you on your individual thoughts on risk and we can supply supporting advice on how much growth you really need in order to achieve a good outcome (for example to retire by 60 or to sustain your current rate of income throughout your lifetime) and how much you can afford to lose i.e. at what stage do investment losses go from being a source of disappointment to genuinely affecting your standard of living.

We know that the key to satisfied investors lies not only in the rate of return achieved, but also in the personal experience of investing. Investing should not feel like a white knuckle ride and, so far as is possible, we will work with you on a ‘no surprises’ basis!

On behalf of Trustees, the Society for Trust and Estate Planners (STEP) have introduced Managed Portfolio Indices, which provide objective guidance on what is meant by low, medium and high risk investments*. Trustees, after all, are investing on behalf of another party (their beneficiary) which means the decisions taken around risk are perhaps even more challenging. We support this approach, which we already use with trustees.

* Maximum anticipated losses are 10% (low risk), 20% (medium risk) and > 20% (high risk). Note that the parameters referenced in these descriptions cannot be guaranteed by the investment manager, however these ensure that a common understanding exists between investment manager and investor.

  • For further information please contact:

    William Thompson

    Chartered Financial Planner, Private Client, Wells

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