The following extract was taken from an article by Gerda van der Linde Executive Director Institute of Behavioral Finance:
“Capital preservation remains a vital ingredient and a major concern for investment strategy over the short to medium term, not taking away the need for capital appreciation over the medium to long term. Without the assistance of an experienced financial advisor it will be hard for the average investor to find the right balance between: the risk you are required to take to reach your goals; your risk tolerance profile indicating your unique level of comfort with uncertainty; and your risk capacity giving an indication of the risk you can afford to take.
Striking the perfect balance between the various risk factors for the investor amidst all the market uncertainties, will lead to a comfortable financial future”.
Gerda highlights three different risk factors applicable to each and every investor:
- required risk
- risk tolerance
- risk capacity
Required Risk (Risk Budget):
An optimal risk & return budget is calculated using software to determine the rate of return required to provide for the investors objective using long-term asset class returns.
Risk Tolerance (Risk Appetite):
Risk tolerance is a personal risk assessment obtained by completing a risk questionnaire. This is a highly subjective measure strongly influence by the emotions of the investor.
Risk capacity is the bridge between the required risk and the investors risk tolerance. This can be viewed as the value of advice. The best way to explain this is using a fictional character like Joe Blogg’s.
Joe Blogg’s great granddaddy lost all his money in the cash of 1929 and since that day, 30 yrs before he was born, the Blogg family (Joe included) became conservative investors. So now 81 yrs later Joe completes a risk questionnaire as required by legislation. The risk analysis indicates that he is a conservative investor. The advisor is now compelled by law to place Joe’s investment in a combination of cash and bonds; guaranteeing that he will never achieve his objective.
Any advisor worth his salt will assist clients in understanding risk and the integral part risk plays in any investment strategy rather than blindly leading their clients of the cliff by following regulatory risk tolerance profiling.
Mcomm, CFP®, HdipTax
T. 021-851 3746