Understanding the risk in your investment portfolio

As a consumer, when it comes to spending money, clarity is key. After all, if you’ve booked a sunshine holiday, you’ll want to know that the destination is Dubai rather than Dublin. And how about that ‘nippy little number’ from the car dealership; you may have always wanted a sports model, but finding out that it’s faster than a Prius but slower than a Porsche isn’t enough detail to allow you to part with the deposit.

Vague labels can be problematic and that includes the level of risk in your investment portfolio. The lack of clarity and detail provided by some investment offerings has been highlighted as a cause for concern by both the Financial Conduct Authority (FCA) and the Financial Ombudsman. So, how can you make sure that you have a clear and detailed understanding of your investment choices – and that your investment portfolio is the right fit for your attitude to risk?

In a recent study the FCA found that investment portfolios from different managers labelled as medium or balanced risk held anywhere from 20%-75% in stocks – a range too wide for such labels to have any real meaning.

Clients identifying as ‘Cautious’ typically prioritise security of capital and are often approaching retirement or already retired. But the same study found portfolios labelled as low risk could have exposure of up to 60% in stocks, potentially resulting in losses of 25% or more in a stock market fall.

In these circumstances, for a hypothetical £400,000 portfolio to lose more than £100,000 could certainly cause surprise and dismay for a cautious client, and is not something we would be prepared to consider at Old Mill. Yet that could be the impact of such subjective and misleading descriptions still in common usage elsewhere.

Everyone has their own understanding of ‘Cautious’ or ‘Balanced’, so there’s really no substitute for a direct conversation with your investment manager about what rate of growth you feel is needed, balanced against how much money you might lose in your portfolio in a bad year.

While we can’t forecast when markets are likely to fall or rise – or by how much – we can look back to what best-case and worst-case scenarios have meant for different portfolios in the past. We can back test portfolios through the market’s most difficult days – such as the financial crisis of 2007, the three-day week of 1973, and Black Monday in October 1987.

We will work closely with you to understand your individual attitude to risk, and advise you on how much growth you really need to achieve a good outcome – for example, to retire by 60 or to maintain your current level of income and lifestyle. We will also advise you on how much you can afford to lose, and establish at what point any investment losses would go from being a source of disappointment to genuinely affecting your standard of living.

We know that the key to satisfied investors lies not only in the rate of return achieved, but also in the personal experience of investing. Investing should not feel like a white-knuckle ride and, so far as is possible, we will work with you on a ‘no surprises’ basis!

On behalf of trustees, the Society for Trust and Estate Planners (STEP) has introduced Managed Portfolio Indices, which provide objective guidance on what is meant by low, medium and high risk investments. Trustees, after all, are investing on behalf of another party (their beneficiary), which means the decisions taken around risk are perhaps even more challenging. We support this approach, which we already use with trustees.