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Discussing Investment Risk

When talking to clients, Financial Advis¬ers are required to consider investment risk. There are many risk profiling tools available for advisers to help under¬stand a client’s attitude to risk but what happens next?

When I joined the industry, understand¬ing risk was much easier than today.

Cash in the bank was considered low risk or even no risk at all. Government Bonds were considered slightly higher up the risk scale and Equities (shares) were higher risk again. Property was not considered risky and gave its name to an English expression, “Safe as Hous¬es”.

In 2008 everything changed. Banks failed, Governments were under finan¬cial stress, Stock Markets fell. Do these events mean advisers should tell clients everything is high risk?

Banks are being recapitalised and in the European Union, Governments guarantee the first €100,000 of a bank deposit. Two caveats to this, the type of account; 1/ not all accounts carry the guarantee and 2/ the guarantee is by banking group, not individual bank. If a depositor has money in 2 banks but they are part of the same group, then only €100,000 is protected.

We are all feeling better about the strength and security of banks so that is the good news. What about the de¬posit rates we are being paid? Is there an inflation risk we should be con¬cerned with? If inflation is running at a rate greater than the deposit interest we are being paid, we are losing money in real terms aren’t we?

We have also seen Countries in finan¬cial difficulty and even being bailed out. Is it therefore always sensible to hold Government Bonds? What hap¬pens to bond values if interest rates rise? Is there a risk the value of Bonds would fall.

We have seen volatility in Equity mar¬kets with some large companies having financial difficulties. At the same time some companies are doing very well, are cash rich and are paying good divi¬dends. Regulators tell advisers we need to understand our client’s attitude to risk and provide solutions to our clients that match those attitudes. The regula¬tors do not yet tell us which asset class¬es represent high risks or low risks. Is it therefore good advice to tell a cautious investor to leave their money on de¬posit at a bank? Almost certainly not. How do we advise a client who wants no risk and a return in excess of infla¬tion? It’s not an easy job.

Our feeling is that the only advice we can offer is to spread the risk, diversify in terms of asset classes, pay attention to liquidity and fully understand any product or portfolio. Now is certainly not the time to have all one’s eggs in one basket!

This article appeared in and was written by Michael Lohdi, Chairman of The Spectrum IFA Group