Risk is part and parcel of managing wealth. Even if you opt to stick your money under the mattress you’ve to consider the risk of inflation nibbling away at it, or mice. When you engage an investment manager, he or she does much of the risk assessment for you.
“When we, as money managers, build client portfolios, we have to think of the risk first and foremost in terms of who our client is and how much risk is it suitable for them to be taking,” says Alan Werlau, Head of Investment Advisory at Davy.
“The business has moved on from being based on particular products to being about gaining a full understanding of a client’s appropriate level of risk.” The yardsticks used measure not just the likely returns over time, but also, what each individual’s capacity for loss is.
“Certain things are givens, as in, how much money you have, how much money you need and how much of a hit you can afford to take.” Returns are not givens. “But what we can do is see how, looking back over a long periods, certain asset classes such as equities, bonds and property, for example, tend to give a certain level of return over time.”
Though past performance is no guaranteed of future performance, over the longer term, a good financial adviser will be able to identify what might reasonably be expected in terms of long-term growth.
“What I can’t tell you is what that return will be in the short or medium term,” he says.
When building a client portfolio, advisers will establish whether aiming for cautious, moderate or more aggressive growth is most appropriate. Traditionally it was assumed that a younger person has more risk tolerance than an older one, because it was assumed they had more years ahead of them to take corrective action than a retiree, for example.
Now that retirement funding models have changed and people will need to continue investing long into their old age, their appetite for risk may change too.
“If a person is earlier in their career, they may have more appetite for risk because they are thinking in longer term timeframes. But equally, a person thinking generationally, in terms of their grandchildren, may take a similar view. So it depends on the person,” says Cleland.
Once the adviser has established the client’s individual risk tolerance, they then assess market risk.
“This could mean seeing where we are on the economic cycle. If we are early into a period of economic expansion, we may allocate more equities, for example. If we are late, we may dial down the equities. It’s about adjusting the risk of the portfolio so that the outcomes are the same. It’s also about taking into account the vagaries of the equities market and building a diversified portfolio as the best way to manage risk.”
Risks change over time too. Right now we are living in a period of low volatility as a result of the exceptional liquidity arising from quantitative easing – Central Banks buying government bonds across Europe, the UK and US. The risk is that QE will end, markets will fall and volatility will return.
Other risks are harder to gauge, such as whether or not to invest in crypto-currencies. It is widely reported that if you had invested $100 in Bitcoin in 2010, you’d be sitting on €70+ million today.
Today you might be better off investing in the technology underpinning Bitcoin, the blockchain, which has enormous applications across a range of sectors. But who knew?
"The underlying technology is fascinating and will ultimately be a huge part of the financial services sector, but we don't believe we have enough expertise on crypto currencies to be advising on it," explains Dan Moroney, investment strategist at Investec Wealth & Investment. "Investec is safe pair of hands. We want to protect people's money and grow it."
