One of the fundamental things that financial planners talk about is a client’s attitude to investment risk. The starting point is usually a questionnaire. It includes questions about a person’s attitude to financial risk, as well as their mental attitude to risk in general.

Some clients try to shortcut this part of the process, saying: “Let’s not worry about that; I’m medium.”

This might be true.

As statisticians know, 68% of the population will be in the middle of any bell curve.

However, a good financial planner looks at three aspects of risk:

  • Tolerance of risk
  • Capacity for risk
  • Necessity for risk

When building an investment portfolio, we consider a client’s capacity and necessity for risk, as well as their risk tolerance. Otherwise, they might end up with a portfolio that is too risky for their needs.

Does your financial goal mean you should accept more or less risk to achieve it?

You might think that people who have a lot of money can afford to take more risk because their lifetime goals wouldn’t be unduly affected even if their investments collapse. A wealthy person could have a large capacity for risk, but taking a risk is not compulsory. If you have a lot of money and your financial goals are not too ambitious, why would you need to take a risk?

On the flip side, a less wealthy person might not have such a large capacity for risk because they can’t afford to lose a large percentage of their wealth. But if they want to buy a Ferrari, take regular holidays in the Maldives, and have tea every day at the Ritz, they would need to take a greater risk to have the best chance of achieving their goals.

What this means to you

Don’t let your financial planner take your risk tolerance at face value. Have a discussion to ensure they explore your capacity and necessity for risk as well. Make time to fill in the questionnaire. The financial questions you’ll be asked measure your capacity for risk. The questions about your goals and objectives measure your necessity for risk. The general questions measure your risk tolerance.

Obviously, at Tucana, we do financial planning according to the client’s best interests (nudge, nudge, hint, hint!). We don’t want to waste your time with unnecessary questioning. We just want to do the job properly.

And now, as they say at the end of any good sermon: “Here endeth the lesson”.

Further reading

For more on this, please see:

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