Understanding Risk and Reward
We all interpret risk in different ways. An understanding of what risk means is influenced by your past experiences and what you are willing to accept in the future.
Financial risk, in the context of your investments, is the risk of losing money. However, in order to grow your investments you need to take on some element of financial risk. It is generally accepted that the more financial risk you are willing to take, the greater the potential financial reward. The downside is that losses suffered could be greater. Where the danger comes is if the risk is not properly understood, managed or controlled and your money is exposed to financial risks with which you are comfortable.
Understanding your tolerance to risk
Before investing, your adviser at Burton & Fisher will assess how much financial risk you are willing to take. As part of this assessment we will also attempt to assess your capacity for loss.
There will be times when certain assets will tend to go up in value at the same time as others fall, meaning you could benefit from a more balanced approach that cushions the impact of an unexpected market downturn. Investing in assets that behave differently is essential in order to effectively spread risk.
At Burton & Fisher we use Dynamic Planner’s risk profile planning tools to help us determine your risk level.
The process helps to build a deeper insight into your requirements and checks the extent of your understanding. As a result of the answers given and the conversations they trigger, both your adviser and you should be confident that the final outcome is an accurate and fair reflection of your risk tolerance and capacity to tolerate possible losses.
Step 1: Complete the psychometric risk profiling questionnaire. The questionnaire was developed with industry-leading psychometric consultancy, Oxford Risk, a company led by academics from the University of Oxford.
Step 2: Dynamic Planner then automatically checks the consistency of the responses and identifies answers outside the expected range, which we can discuss together.
Step 3: You then complete a few additional questions relating to your investment timeframe, capacity to tolerate possible losses and liquidity requirements.
Step 4: The selected risk profile gives a score out of 10, a Plain English explanation of how comfortable you would be with the possibility of losing investments and investing in higher-risk investments to get better returns, a likely portfolio asset allocation and an indication of the expected range of returns over 12 months.
Although there are 10 risk profiles the following are the risk profiles Burton & Fisher would normally expect our clients to have:
An investor who is a Risk Profile 3 – LOW – is likely to be concerned about the possibility of losing money on their investments, but does not want to completely ignore the possibility of making higher returns than are offered by bank accounts and low-risk investments. As a result, these investors are willing to sustain very small losses on the amount invested by investing in lower- and medium-risk investments such as cash, bonds and property in order to achieve a higher return.
An investor who is a Risk Profile 4 – LOWEST MEDIUM – would probably be concerned about the possibility of losing money on their investments, but may also want to achieve higher returns than are offered by bank accounts and low-risk investments. As a result, these investors are willing to accept only small losses by investing in some medium-risk assets such as property and possibly some shares, in order to achieve a higher return.
An investor who is a Risk Profile 5 – LOW MEDIUM – is prepared to accept small losses, particularly in the short term, to gain higher returns than simply investing in low-risk investments. An appropriate investment portfolio would consist of a balanced mix of lower and medium-risk investments such as bonds and property as well as some higher-risk investments such as equities.
An investor who is a Risk Profile 6 – HIGH MEDIUM – is prepared to accept some losses, particularly in the short term, to achieve higher returns than by simply investing in low-risk investments. An investment portfolio within this profile would consist mainly of higher-risk investments such as shares with some lower and medium-risk investments.
An investor who is a Risk Profile 7 – HIGHEST MEDIUM – would want to make higher returns on their investments, although they are still concerned about medium sized losses on their investment portfolio. An appropriate portfolio for this profile would primarily contain equities with a few lower and medium-risk investments such as bonds and property.
An investor who is a Risk Profile 8 – HIGH – has a ‘high’ attitude to accepting risk and concentrates on getting higher returns on their investments. An investment portfolio suited for this profile would consist in a high proportion of higher-risk investments such as equities, with the occasional lower- and medium- risk investments.
Dynamic Planner provide an asset allocation for each risk profile. They are able to provide a stochastic analysis for each of the target asset allocations and provide a range of ‘what if’ scenarios to help us explain to you the expected risk and reward characteristics over defined time periods.
The asset allocation is expected to deliver a combination of risk and reward deemed best aligned to your needs over the long term.
The underlying asset allocation model is used to provide forecasts of expected returns and volatility of 15 core asset classes. Typically these assets represent the most important constituents of the majority of available collective investment funds.
Burton & Fisher Portfolios
At Burton & Fisher we carry out research on the funds available for you to invest in. This research is constantly monitored and our Investment Committee meet on a quarterly basis to agree on the funds we recommend.
In our assessment we consider the following (amongst other things):
- Cumulative Performance of all funds over the last three and five years
- Discrete Performance of all funds over the last five years
- Annual Quartiles of all funds
- The Ongoing Charge of all funds
- The Financial Express Rating of all funds – Crown Rating from 1 to 5, where 5 is best.
This helps us define a short list of approved funds and from this our preferred fund list.
Using the asset allocation for each risk profile and the preferred fund list we are then able to produce individual portfolios for each risk profile.
As an example here is the ‘Burton & Fisher Portfolio 5’. This is the proposed asset allocation which links with a client with a Risk Profile of 5 – LOW MEDIUM.
The above asset allocation produces the following portfolio from our preferred fund list:
|Artemis High Income I||15%|
|First State Asia Pacific Leaders B GBP Acc||6%|
|Invesco Perpetual Monthly Income Plus Y Acc||15%|
|Jupiter European I Acc||5%|
|Jupiter UK Growth I Acc||7%|
|L&G UK Property Feeder I Acc||7%|
|Old Mutual UK Alpha U1 Acc||7%|
|R&M UK Equity Smaller Companies B Acc||7%|
|Schroder Tokyo L Acc||5%|
|Threadneedle UK Equity Income Z Acc GBP||7%|
|Vanguard UK Long Duration Gilt Index Acc||5%|
|Vanguard US Equity Index Acc||14%|
And the past performance of this portfolio is as follows:
Please note that this information is correct as at 22 May 2015.