As we have written in previous blog posts, risk is a broad measure that needs to be evaluated in the proper context. The overall risk is based on the combining effect of the various risk factors at play. We have written somewhat extensively about the types of risks that investments may possess and while the expectation is not for clients to become risk experts – that’s our job, having a general awareness is important. When it comes to evaluating the overall risk tolerance of a client, we use a multi-pronged approach which goes beyond simply filling out a questionnaire.
The first focus is on the level of risk needed in order to achieve a client’s goals. For example, if a client has a sufficient savings fund built up, in tandem with a modest retirement income expectation, there probably doesn’t need to be a lot of risk employed within the portfolio. Secondly, we look at the portfolio’s capacity to endure risk, which is usually related to timeline. If a client has a time horizon of twenty plus years, the portfolio is better able to weather any short-term fluctuations than someone with plans to liquidate their portfolio in the very near future. Lastly, and most importantly, is evaluating a client’s comfort level with risk – what I like to call the ‘sleep at night test.' Is the level of risk going to allow them to sleep at night or will they be tossing and turning feeling stressed about short-term fluctuations within their portfolio?
This last factor, that of a client’s comfort level, will always be the underlying factor taking precedence above all else because we will never go beyond what a client is comfortable with. If a client is generally agreeable to the concept of risk, then we look at the combination of their portfolio’s ability to endure risk, as well as not taking any more risk than necessary in order to meet the financial objectives that have been previously discussed. Having a transparent conversation with clients concerning risk is pivotal to implementing an effective portfolio strategy.
Janet Kim Sing, Portfolio Manager
Capstone Private Wealth