The risk in not taking risk:
An overreliance on client risk profiling can result in sub-optimal advice  

17 May 2018: Johannesburg – How do you react when your pension fund dips in value? What do you do when your friends boast about spectacular profits from complex investments? Do you prefer ‘safe as houses’ cash investments or more glamorous ‘equity only’ unit trusts? Your answers to the above questions vary based on your unique ‘relationship’ with money.

An understanding of this relationship, including the individual’s take on concepts such as risk and return, is an important part of the financial planning process. This is one of the reasons why financial planners ask their clients to complete a risk assessment questionnaire as early as possible. “The risk assessment aims to determine a client’s appetite for risk,” says Mark MacSymon, CERTIFIED FINANCIAL PLANNER® professional and proud winner of the 2017 Financial Planning Institute’s Financial Planner of the Year award. 

However, he warns that solely relying upon a risk assessment to determine how a client’s assets should be positioned can lead to sub-optimal advice. “The ‘money relationship’ debate is complex and should include a discussion about the client’s attitude to risk (risk appetite), their need for risk and their capacity for loss,” he says.

An individual’s attitude to risk exhibits in behavioural terms through statements such as “I prefer stable returns” or “I am adventurous” and the traditional practice is to translate an individual’s risk attitude into an appropriate risk category, for example ‘conservative’, ‘moderate’ or ‘aggressive’. Financial planners, meanwhile, think of risk simply as the volatility of returns generated on the client’s investments. If the client’s portfolio offers a smoother ride over time, then there is more certainty and it is regarded as less risky than the portfolio that produces a return profile with bigger ups and downs.

Short duration investments such as money market instruments can be viewed as low risk, characterised by price certainty with only minor price fluctuations over time. “Investors can be very certain of the return they will receive when they place money in the money market,” says MacSymon. “Investing directly in equities (shares) is a more uncertain experience as the price variability in the short-term can be extreme”.

A client’s need for risk is based on the return required to achieve his or her long-term investment objectives, tempered by the reality that the higher the return required, the higher the risk. “There is generally a positive relationship that exists between the volatility of an asset class and the expected return an investor will receive over the long-term,” notes MacSymon. “Asset classes such as equity and listed property, whilst more volatile in the short-term relative to bonds and cash, will almost certainly outperform the latter over a period exceeding seven years”.

An individual’s risk appetite is also closely linked to their financial goals, for example to maintain their standard of living during retirement, to educate their children or to leave a legacy. Good financial planners will help their clients to prioritise these competing goals into those that are ‘must haves’ which include for instance planned living expenses and education costs versus those that are more aspirational in nature.

If their goals are modest they would not need to target huge returns and could therefore invest in a portfolio of lower risk assets delivering reasonable returns without much downside. But if they target goals which are possibly beyond their financial means, they will require higher returns with a commensurate increase in risk. This is where it is critical that financial planners counsel clients toward setting and attaining realistic goals and draw the line between investment structures that are supportive to achieving those goals and structures that are not. 

A client’s investment time horizon has a big impact on risk and return too. “We need to be cognisant that investors have different objectives or goals for which their resources need to be positioned – goals include funds for retirement, for travel, for children’s or grandchildren’s education, for the purchase of businesses and property and for imminent expense obligations,” says MacSymon. “The ideal asset allocation for achieving investor goals over varying time horizons differ immensely”.

MacSymon follows a goals-based approach to wealth management. By constructing the investment planning component of a financial plan using this framework the financial planner can mitigate any potential disconnect between a client’s required return and the level of risk that he or she can afford to take on. Some clients need investment solutions that are conservatively positioned relative to their calculated risk profile; others are positioned more aggressively.

“It is important that your financial planner considers your attitude, need and capacity when structuring risk-appropriate portfolios,” concludes MacSymon. “Each client has a different combination of these attributes which will change over time, which makes partnering with a wealth manager that understands these nuances an absolute imperative”.

Ends

Compiled by:
Gareth Stokes
Stokes Media Group
E: gareth@stokesmedia.co.za 

Media contacts:
The Financial Planning Institute (FPI)
Tsholofelo Dihutso CPRP
Communications and PR Manager 
T:(011) 470-6000
E: media@fpi.co.za  

About Mark MacSymon, CFP®
Winner of the 2017 FPI Financial Planner of the Year competition and a wealth manager at Private Client Holdings (www.privateclient.co.za), Mark has been recognised nationally for the quality of advice he provides his clients. 

Mark completed an Honours Degree in Financial Economics and a Master of Commerce (majoring in Economics) at the University of Stellenbosch and became a CERTIFIED FINANCIAL PLANNER® professional in 2011. Additionally, he completed the Advanced Postgraduate Diploma in Financial Planning through the University of Free State (Estate Planning & Asset Types and Investment Instruments) and is committed to ongoing studies within the financial planning profession. 

Although he regards a strong academic background as essential to rendering a quality financial planning and wealth management service, Mark believes first and foremost that the most valuable commodity in the financial planning profession is trust – built over time. He is passionate about advancing the financial planning profession and is committed to making a difference to his clients’ lives by nurturing their financial security and prosperity.

About the Financial Planning Institute of Southern Africa
The Financial Planning Institute of Southern Africa (FPI), a South African Qualifications Authority (SAQA) recognised professional body for financial planners, which serves the public by ensuring that people who carry the CFP® designation are qualified, experienced and professional. FPI has recently been approved by the South Africa Revenue Services (SARS) as a Recognised Controlling Body (RCB).

The Institute is also recognised internationally and is a founding, and a current affiliate member, of the international Financial Planning Standards Board Ltd (FPSB) based in the USA, along with 25 other affiliate member countries who offer CFP® certification, the highest recognised professional designation worldwide for a financial planning professional. 

In 2012, FPI was highly commended by FPSB and awarded Tier 1 Affiliate Status for receiving 96% in the global assessment. This is the highest achievement any affiliate has ever received. For more, visit www.fpi.co.za or follow @FPISANews.