Nick Lincoln: capacity for loss 'intellectually bankrupt'

Assessing a client’s capacity for loss may keep the regulator happy but it is 'pointless', says adviser Nick Lincoln. In this opinionated piece, Lincoln explains why he thinks focusing on losses is misguided compared to the real danger of inflation

To my dying breath I will cling to the central notion that our role on this planet is to tell clients what they need to hear, rather than what they want to hear. This was front of mind as I read Jacqueline Lockie’s article.

Implicit in her piece was the notion that risk is all about volatility (it is not, but more of that in a moment). Trampolining off this canard was the explicit conclusion that, as advisers, we must spend (and be seen to be spending, for compliance sake) precious time to somehow ensure client portfolios are reflective of the risk each client is able and willing to bear.

Even if this was achievable (it is not), it is pointless. Not only would one be trying to slay a dragon, it would be an exercise in slaying the wrong dragon.

To my dying breath I will cling to the central notion that our role on this planet is to tell clients what they need to hear, rather than what they want to hear. This was front of mind as I read Jacqueline Lockie’s article.

Implicit in her piece was the notion that risk is all about volatility (it is not, but more of that in a moment). Trampolining off this canard was the explicit conclusion that, as advisers, we must spend (and be seen to be spending, for compliance sake) precious time to somehow ensure client portfolios are reflective of the risk each client is able and willing to bear.

Even if this was achievable (it is not), it is pointless. Not only would one be trying to slay a dragon, it would be an exercise in slaying the wrong dragon.

Volatility is not risk

The constant seesaw of stock prices is not risk. It is normal and something to be welcomed. We need to be constantly reminding all of our clients of this, all of the time.

The real risk for nearly everyone is seeing the value of their money wiped out by inflation over a three-decade-plus-retirement period. Everything else is noise.

By way of prosaic example: my first pint of beer in 1986 cost 96p. The equivalent beer today, sold by the same pub, is around £4.80. A fivefold price increase, in just over 30 years, of a classic discretionary spending item.

In place of beer, insert: gym membership; eating out; holidays; theatre tickets; school fees for the grandchildren; private healthcare etc.

Or: I would have needed £1,000 in 2004 to purchase what £105 could have bought in 1969, the year of my birth. Three-and-a-half decades’ worth of inflation wiped out 90% of the purchasing power of our currency.

Completing endless attitude-to-risk questionnaires will not address this risk. By the way, if you think annually subjecting clients to this nonsense is beneficial to anyone, then I have a bridge to sell you.

Capacity for cash

Likewise there is the intellectually bankrupt notion of capacity for loss. On what planet do we give credence to this chimera and those who promote it? I am looking squarely at you, burgeoning compliance consultancy industry.

Aside from the fact it is built on pillars of sand – for there is no loss, ever, if there is no sale – it again draws the attention away from the real risk: inflation.

Latterly in her article, Lockie rightly asks: ‘how many [planners] work out what overall rate of return of an entire portfolio is needed to meet all their [client] objectives as they arise?’ I would hope the answer is ‘all of them’, otherwise they are not financial planners, regardless of how many qualifications they have, or the number of professional bodies they belong to.

My take? You cannot recommend an investment portfolio for a client without a financial plan. The plan determines the rate of return needed to drive the plan to a successful conclusion. This, in turn, informs the portfolio, absolutely and without exception. No plan, no portfolio.

And what do we learn from the construction of such plans? That a fixed income is invariably a fixed outcome: penury. A three-decade cashflow forecast in which ‘typical’ retirees remain in cash/bonds will invariably show them running out of money before they run out of life.

Investing is not done in the abstract. It is done as a direct consequence of, and a solution to, the incredible risk of seeking illusory long-term sanctuary in cash.

Entering retirement, most people will have little or no capacity for cash. This is what clients need to be told about. This is risk. This is life and death for their money.

Boxes ticked

By all means, indulge your compliance department and get the clients to fill out the mumbo-jumbo questionnaire. Do it annually, if it makes you feel better. Heck, go to town and do it daily.

Plough ahead and waste more time in assessing the client’s capacity for loss. Good luck with that: the clients will not have a clue and you will not be far behind them.

Do both these things and then, but only then, God forbid, put these poor saps into their ideal ‘boxes ticked’ portfolio. The one that has low volatility; will never cause a permanent ‘loss’ and which will be wiped out by inflation and charges over time.

Never mind. You have given the clients what they want: a portfolio that matches their risk appetite and won’t keep them (and much more importantly, your compliance function) awake at night.

Until the money has gone. But there is an alternative: legacies not liabilities.

Straight talking

Have an adult conversation. Talk about the real risk of inflation wiping out the purchasing power of their hard-earning savings.

Ask clients what it will feel like to have to sell the family home, not out of choice, but necessity. Ask them what it will feel like to go cap in hand to their children in later life. Ask them about leaving not legacies but liabilities.

Am I saying equity-leaning portfolios are for everyone? No. If you really cannot stomach a 30% or more temporary decline in your portfolio’s value roughly every six or seven years, you cannot be saved.

Accept you will have to work longer or save more. Or spend less (but I could never, with apologies to Jacqueline Lockie, tell clients where they should make lifestyle cost savings.)

All their lives clients have been inculcated in a culture that defines risk as volatility. A culture that screams ‘the stock market is where fortunes go to be lost.’ We – empathetic, caring financial planners – are the first people our clients meet in their lifetimes who say otherwise.

And say it we must, because it is true. And if that is not reason enough, I don’t know what is.

Nick Lincoln is director at Values to Vision Financial Planning

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