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Guiding clients through the risk reward payoff

22 July 2018

Conversations around risk and reward should be a regular part of the client review, says Jamie Evans, business development manager, Seven Investment Management

In the early conversations that advisers have with their clients, one of the most fundamental focuses on the balance between risk and reward. It’s also a conversation that needs to be repeated as financial goals and lives change.

However, for lots of clients, it can be a while before this conversation is repeated given it is, more often than not, prompted by a ‘life event’. These can be anything from getting married (again sometimes) to selling a business etc. and so (hopefully) don’t happen on an annual basis.

We question that methodology though. That’s because a series of smaller changes in life – e.g. changing jobs, moving home – could collectively have a significant impact on your clients’ finances. Yet these wouldn’t necessarily prompt a review.

We do realise that the risk-reward conversation is often an inherently difficult one – perhaps why it doesn’t happen as much as it might. Research run by 7IM and the London Institute of Banking and Finance highlights this. We asked 2,000 over-50 year olds whether they’d changed their risk profile in the last year. Two thirds said they hadn’t – quite a significant percentage given this age bracket includes those coming up for retirement (and have only just realised it), who are retiring and, incidentally, the demographic with the fastest increase in divorce rates in the UK.

The difficulties here lie in the fact that you’re asking people to set out how their lifestyle will look at some point in the undefined future – not always an easy task given how many members of their families the decisions impact.

It can also prove to be drawn out, because we as humans, are naturally averse to risk – which I talked about in my last article– and especially if the rewards are difficult to quantify. Conversations about risks and the potential rewards also have to be caveated for regulatory purposes, given investments can go down as well as up, to the point where your clients’ original investment is impacted. This probably makes them even more unpalatable to clients!

It is important though that conversations take place regularly. If you don’t walk clients through the choices they’re making and highlight how a small step up in risk – we’re not advocating taking the maximum amount of risk at all – can help them more easily achieve their financial goals and aspirations. Not taking that step may mean they’re due to run out of money and it’s too late to do anything about it.

To highlight how important it can be, we set up two hypothetical portfolios based on two investors each saving between the ages of 30 and 60 to aim to retire with £22,000 a year in income. Over the whole period, each saved an average of £7,500 a year. To make it more realistic, the investors started paying in £500 a year, which was ratchetted up by £500 more each year.

One investor had a moderately cautious portfolio, which seeks to deliver a 4% return a year after fees over the long term. The second invested in a balanced portfolio, aiming to achieve 5% a year after fees over the same timeframe.

At the age of 60, the results of these different risk decisions showed. Our first investor had a portfolio of about £375,000, while the second had circa £425,000. Looking into the future, if both were to withdraw their £22,000 a year, and the investment returns remained on track, the first (the moderately cautious investor) would run out of money at the age of 86. The balanced investor meanwhile would still have around £275,000 invested at this point. The problem is obviously that the first investor may live longer than 86!

So perhaps it’s worth scheduling those client conversations to assess where your clients stand, and how their finances could change?

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