Recent work with a few new clients in St Francis Bay has again highlighted the danger of what I see as an absolute Scourge in Financial Planning, namely, Risk Profiling. In short this is where a client after filling in a risk analysis questionnaire or even just based on their age get labelled and high, medium or low risk. The result is that their investments then get setup to reflect this label and deliver a return on investment based on that specific asset allocation. The result is a pot of wealth that they then need to live off for the rest of their life.

All this process does is protect the adviser who doesn’t want to do the work to understand what the client really needs or to explain to the client why they may need to target a higher return to achieve their long-term plan. If the clients’ outcomes are not what they want the adviser points to the questionnaire that the client completed decades ago. LAZY!

One of the problems with this approach is the language used. Instead of an investment portfolio being called a high, medium or low risk portfolio, they should be called high, medium or low return portfolios as this is much closer to the truth and reflects the real outcome. Also, the work “RISK” triggers emotion and should be replaced by “VOLATILITY” which more correctly reflects the nature of responsible investing.

The biggest shortcoming of risk profiling however is that it focuses on the money and not the person/family. By turning the above process on its head far better results can be achieved for the client. This means first understanding the clients existing lifestyle and the lifestyle they want to enjoy for the rest of their lives. Once this has been clarified, understood and costed, the necessary return on existing and future investment contributions can be calculated.

The asset allocation to get this return is straight forward to work out and this will have a level of volatility which the client needs to be comfortable with. If the return needed is too high or the volatility too much for the client to bear, then adjustments need to be made to the actual and/or desired lifestyle until the outcome is achievable.

 

This process will give the client what they need and highlight any changes that may be necessary in their current or future lifestyle expenses. This is proper planning and takes a bit of time, but hey, we are talking about the rest of your life?

If your adviser has “labelled” you into one of these categories or if even scarier you have no idea what you are actually invested in, then take the time to find out, your future self will thank your current self.

We are all unique, we all want different things. This is what makes life so wonderful but to make sure we can achieve these things we need to understand what needs to happen now with our investments to make sure our future self is living the way we plan.

Dirk Groeneveld, Certified Financial Planner.

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