Chapter 7 (11 exam questions) – The Investment Advice Process Flashcards
FOR CONTEXT: The 6 official steps to giving advise are:
see image
This chapter links heavily with chapter 8
What is the purpose of the client agreement (also called customer agreement)
This tells the client about the services offered by the advisor,
This includes remuneration, how often reviews will take place and so on
What does the fact find establish
Soft and hard facts
Hard facts relate to factual information such as a customer’s salary and occupation.
Soft facts refer to their needs, wants, desires and feelings.
There are three main factors to consider when creating someone’s risk profile
What are they?
What is their attitude to risk (subjective)?
What is their tolerance to risk (subjective)?
What is their capacity for loss (objective)?
A questionnaire is typically used as part of the factfind. Why is this?
A good questionnaire aims to elicit a personal response rather than a reaction to what everyone else is doing. People often tend to imitate others (herding) and this could mean their answers about their risk tolerances are skewed. Good questionnaires prevent this
Modern questionnaires usually incorporate questions that will elicit attitudes and tolerances.
They would have questions such as: “How would you feel if the value of your investments fell by 25%”, with a range of answers to choose from.
What is mental accounting in relation to attitude for risk?
It is a term used for this whereby a customer may be prepared to accept a higher risk on say their regular savings than when investing a lump sum
What are ‘stochastic’ modelling tools.
The range of possible returns from a selected asset allocation can be measured over any period of time, and a model of ‘likelihood’ can be created.
This enables them to link risk discussions directly to asset allocations.
When it comes to a portfolios performance. What typically has a bigger effect. Asset allocation or the individual selection of stocks themselves?
Asset allocation
Why is it not fair to bracket all equity funds as higher-risk
A fund investing in established UK shares will generally be less risky than one that invests in smaller companies like ‘alpha’ funds.
Ethical funds differentiate themselves through different types of screening.
Tell me about this
The different types of screening (see image)
Generally, it is easier to invest ethically through collective investment schemes, which will have rigid screening processes in place. WHY?
Trying to screen directly is very difficult with a number of investments and very subjective.
Clients may initially want to achieve a particular return, but it’s not until an adviser brings risk tolerance into the conversation that a more achievable or acceptable objective emerges.
This is where an adviser’s soft skills can come to the fore by asking ‘what if…’ or ‘how would you deal with…’ questions.
There are two main Investment types that these objectives fall into: WHAT ARE THEY
There are five accepted risk categories into which investors can be classified.
These are:
No risk
Low risk (cautious)
Medium risk (balanced)
Medium/high risk (adventurous)
High risk (speculative)
Tell me the differences between each, including what the typical investments found under each type are and what is accepted/not accepted in relation to investment performance
Context
What is time horizon
When considering an investment, an adviser needs to take into account the timeframes the customer has.
Risk is closely related to time horizon, especially with equities. Equities experience the widest fluctuations in value, and investing in these over short time-periods can be very risky. Research has shown that equities only really start to consistently beat other asset class returns after ten years or more, so an investor must be prepared to invest for the long haul.
Is it better to repay debts with your money or save and invest it?’
Secured debts should always be repaid first. Although they typically carry lower interest rate, the ramifications of default mean that it is better to carry unsecured debt. Certain expenditure, such as mortgage payments, council tax, utilities should always take priority in a customer’s budgeting.
Using the concept of ‘asset allocation’ means that an adviser can create pre-designed portfolios that are tailored to the needs of ‘classes’ of customers.
What is Strategic Asset Allocation?
What is Tactical Asset Allocation
Strategic Asset Allocation (SEE IMAGE)
Tactical Asset Allocation = Where you start with a base allocation like with SAA but there is a range, for example, plus or minus 10% or 20%. The investor can overweight or underweight an asset class depending on how valuable they see it
In the images example if it was TAA instead with the same base allocation, shares could go anywhere between 40% and 80%, bonds anywhere between 10% and 50% and cash zero to 30%.
These are known as ‘strategic ranges’
A fund manager is ‘applying his skills’ far more in a tactical model than in a strategic one.
What is rebalancing?
Is it automatic or on request?
A form of asset allocation
I client may use the Strategic Asset Allocation approach and for example, have a base split of 50% equities and 50% fixed interest (see image)
However, in the example because of how the respective asset class has preformed now its moved to 61% in equities and 39% in fixed-interests. This obvs makes the fund riskier
Because the fund manager must stick with the agreed allocation they ‘rebalance’ and bring it back to 50:50 as the investor wants
Rebalancing can be done automatically or ‘on request’.
We know the meaning of accumulating wealth, but what is ‘decumulating’ wealth? .
One of the main definitions: The conversion of assets accumulated during an individual’s working life into income to be spent during retired life.
advising on decumulation is becoming more common as people are living longer
