14. Advice Flashcards
Investment advice - Factors to consider
14.2 Factors to consider
- Attitude to risk
- The client’s objectives - Income vs growth, flexibility, liquidity
- Age and the life cycle
- Current and future circumstances
- Timescale
- The client’s tax position
- Attitude to sustainable investment
Possible client risk profiles
- No Risk/Risk Averse: Prefers no risk at all.
- Low Risk/Cautious: May accept minimal risk if necessary.
- Medium Risk/Balanced: Accepts some controlled risk for a portion of capital.
- Medium to High Risk: Open to higher risk for higher rewards, accepting possible losses.
- High Risk/Adventurous: Willing to take substantial risks for growth.
Capacity for loss
Definition of Capacity for Loss
- Determines if a client’s lifestyle or financial stability would be affected if they lost some or all of the invested funds.
- Distinct but complementary to risk tolerance in assessing investment suitability.
Key Factors Impacting Capacity for Loss
- Existing Debts: Clients with debts are more vulnerable to the effects of losses.
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Future Capital Needs: Any future financial commitments may be at risk if losses occur.
Proximity to Retirement: As clients near retirement, they have less time to recover from losses, reducing capacity for loss.
Client Understanding
Ensure clients clearly understand capacity for loss considerations versus their general risk tolerance.
Establishing the client’s attitude to risk - types of risk (List 6)
Establishing the client’s attitude to risk
- Capital Risk: Potential for loss of the original investment.
- Income Risk: Potential fluctuation or loss of income produced by the investment.
- Investment Types: Understand risks of different assets (e.g., deposits vs. shares).
- Time Horizon: Short-term = secure investments; medium/long-term = asset-backed (stocks/shares).
- Objective Risk: Balancing caution and adventure to meet investment goals.
- Single vs. Pooled Investments: Higher risk in single shares; pooled investments offer diversification.
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Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - interview approach
Interview Approach Summary
Purpose: Gauge client’s feelings on risk and investment.
Questions Focus:
* Existing investments, performance, and concerns.
* Reaction to potential losses or missed targets.
* Views on risk-reward, capital security, and investment understanding.
Outcome: Subjective assessment of client’s risk tolerance based on responses.
Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - Menu approach
Method: Adviser explains risk tolerance categories; client self-selects their fit
Considerations:
- Outcome depends on adviser’s skill and client’s category comprehension.
- Potential for adviser bias or client’s response alignment to perceived expectations
Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - psychometric approach
Purpose: Assess psychological attitude to risk (knowledge, experience, personality).
Method: Statistically validated tests + questions
Focus Areas:
* Personal feelings on risk tolerance.
* Past financial decisions.
* Reactions to “what if” financial scenarios.
* Responses to hypothetical financial events and outcomes.
Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - portfolio approach
Portfolio Approach Summary
Method: Client reviews hypothetical portfolios with varied risk-return levels (low, medium, high).
Purpose: Client’s portfolio choice indicates risk tolerance, guiding asset allocation.
Risk Categories:
* Risk averse
* Low risk
* Medium risk
* High risk (speculative)
Key Points on Investment Objectives and Timeframes - Short-term objectives
Short-Term Objectives:
- Best suited for deposit-based investments to protect capital.
- Equity investments are too volatile for short timeframes, risking capital losses.
Key Points on Investment Objectives and Timeframes - Medium to Long-Term Objectives:
Medium to Long-Term Objectives:
* Asset-backed (equity) investments may be suitable if short-term capital loss is manageable.
* Recommended holding period: 5-7 years to endure market fluctuations.
* Longer timeframes increase the likelihood of positive returns with asset-backed investments.
Key Points on Investment Amount and Emergency Funds
Emergency Fund Recommendation:
14.2.6 The amount
Investment Amount:
- Small Portion of Wealth: Allows for higher risk tolerance.
- Single Source of Capital: Requires a more conservative approach.
- Large Investment: Enables diversification across various assets, including speculative ones.
Growth Needs and Objectives:
- Aggressive Targets with Limited Funds: May require a speculative strategy or a reevaluation of goals.
Emergency Fund Recommendation:
- Maintain liquid reserves as an emergency fund.
- Common benchmarks:
- 3-6 months of income or regular expenses.
- 10% of total capital (minimum a few months’ expenses).
Key Points on Taxation and Investment Decisions - 4 points to consider
1.Current and Future Tax Position: Evaluate the client’s tax status now and potential changes ahead.
2.Income vs. Capital Growth:
* Income-Generating Investments: Can increase income tax liability.
* Capital Growth: May be more tax-efficient if capital gains allowances are unused.
3.Tax-Free Options: Consider transferring investments into tax-free vehicles if possible.
4.Tax Law Changes: Base decisions on current legislation, not speculations about future changes.
Fund switching key points - what is ‘churning?’
Regulatory Perspective:
- FCA views switching (or “churning”) critically; must serve the client’s best interests.
Cost Justification:
- Switching should be justifiable in terms of costs, which are often low due to competitive share dealing and rebates.
Legitimate Reasons for Switching:
- Client Circumstances: Changes in objectives (e.g., nearing retirement) may necessitate moving to lower-risk investments.
- Profit Taking: “Banking” profits and reassessing investment strategy.
- Rebalancing Portfolio:Adjusting asset allocation for diversification or due to performance shifts.
- Underperformance: Switching to better-performing funds/stocks if existing investments underperform over the medium to long term.
- Market Conditions:Adapting investment strategy in response to changing market or economic conditions (e.g., shifting from equities to bonds in a declining market).
What is ‘negative screening’
14.3 Environmental, socially responsible and ethical investment
Negative Screening Definition
Practice: Excluding companies from investment options based on specific criteria.
Criteria: Typically involves a company’s involvement in activities such as:
* Environmental harm
* Human rights violations
* Tobacco or alcohol production
* Weapons manufacturing
* Gambling operations
Environmental, socially responsible and
ethical investment - key points
Definition: SRI involves investing in companies that align with investors’ values and beliefs, emphasizing ethical considerations.
Approaches:
- Ethically Screened Funds: Specific funds that exclude companies based on ethical criteria.
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Engagement Only: Investment strategies that focus on active voting and encouraging better business ethics without excluding companies.
Environmental Investment: A type of SRI focused on investments that support environmental objectives, often referred to as “eco” or “green” investments.
ESG Criteria:
- Environmental: Evaluates impact on climate, energy consumption, waste management, etc.
- Social: Assesses treatment of employees, human rights, diversity, and community engagement.
- Governance: Analyzes management quality, corruption, and corporate governance practices.
Investment Philosophy: ESG investing emphasizes achieving a balance between ethical responsibility and profitability, focusing on companies that score highly on ESG criteria while still aiming for financial returns.
