Managing client expectations and capacity for loss
The start of the New Year seems a perfect time to talk about risk and volatility. To put this into layman’s terms, risk is essentially ‘how much an investment could/can lose’. This should be realistically linked to the question, ‘how much can you afford to lose?’ when assessing a client’s needs and objectives.
The end of 2017 saw off another favourable year in the markets. With both the FTSE 100 and the Balanced Managed Sector returning around 10% in 2017, and totalling almost 50% in the last 5 years, most investors have had a generally smooth ride over the last few years. The Lloyds Bank Private Sentiment index reported that 2017 saw investor sentiment almost double.
Managing client expectations can be a difficult aspect of the financial planning business. As a financial planner, one of the most important steps when speaking with clients is to assess their capacity for loss and educate them about investments. This is especially true when the client has had little exposure to investing. It is therefore imperative to provide clients with a realistic perspective based on historical market performance right from the start, as well as how future markets may behave.
Being able to assess the amount of risk that a new client can emotionally take, is also critical when explaining the varied levels of risks associated with different types of investments. One of the hardest things to explain to clients whose expectations are not met is that investment performance is always relative ie how did their portfolio compare with overall markets? Alternatively, another phrase I use a lot with clients is that ‘you cannot have your cake and eat it too’! Some clients may want to go adventurous with their approach, but then get dissatisfied with large losses. Conversely, a client may be cautious, but expect a high level of growth.
To summarise, the levels of loss within client investments should ALWAYS be in line with their Attitude to Risk. This should be reviewed at least once a year and the client should be made aware if their investments are not in keeping with their risk profile. Clients should also be informed of realistic levels of growth and potential losses.