As a client you will be aware that we ask you to complete a risk questionnaire before we make any investment recommendations. If you are a long-standing client, you will also be aware that we update it regularly.
The initial purpose of the risk questionnaire is to identify how you would act and feel in different financial circumstances. Another purpose of the risk assessment is that it allows us to build a portfolio that takes into account both your attitude to risk and also your investment needs. Your attitude to risk is measured by the score from your questionnaire. Your investment needs are measured by your cash flow results which gives us a ‘rate of return required’ to achieve your goals.
So, its quite possible to have a medium/high attitude to risk but we then recommend a cautious/medium investment profile if our software tells us you don’t need to take a high level of risk to achieve your objectives.
Effectively, your attitude to risk (also known as your risk tolerance) gives us an indication of your well-considered view of the balance between long-term risk and returns.
However, a couple of the challenges with the attitude to risk questionnaire is that it asks hypothetical questions plus your answers will factor in your current mood, which is often based on current/recent market conditions. This is especially true for existing clients when we review their risk profile. When we review a clients attitude to risk, we often find a client increases their attitude to risk score if they’ve had a few years of strong performance prior. We also see risk scores go lower when the performance of their portfolio has been lower in recent times.
In other words, your attitude to risk doesn’t always reveal another important personality trait, which is your investment composure. Your composure is a measure of your tendency to become anxious during your investment journey. Your investment composure is different to your risk tolerance as its more about short-term emotional reactions to real events, rather than long term views on hypothetical events.
So, its possible to have a high attitude to risk but low investment composure. According to Oxford Risk there are 3 categories of investment composure – Low, Medium and High. The descriptions for these categories together with their investment behaviors are shown below-
|Composure Level||Description||Traits to avoid|
|Low||You may be made anxious by the temporary ups and downs in the market and focus too strongly on the short term.||You may be more likely to trade too frequently, or to buy high and sell low due to your emotions acting on short term circumstances.|
|Medium||You may occasionally worry about the temporary ups and downs in the market.||This may only be an issue when things become particularly stressed.|
|High||You are relatively unaffected by the temporary ups and downs in the market and stay focused on the long term.||This trait can sometimes mean you don’t pay any attention, or don’t take the time to ensure your overall wealth is properly organized and invested.|
If you identify as an investor with low composure, then you may need guidance from us to help you avoid the temptation to sell your investments during difficult times. The driver behind this type of act is to seek emotional relief but, based on historical statistics, this is often a bad decision. If you think about it, the chances of selling at the market low point is quite high here. Furthermore, if you then want to buy back into the market when everything ‘is growing nicely’, its highly likely you’ve missed the rebound because that emotional feeling is being brought about by recent past growth….and its future growth we want, not past growth that you’ve missed!
On the other hand, if you identify as someone with high composure, you may need to be encouraged to pay more attention to your portfolios to ensure it is efficient and remains in line with your objectives. You may also need guidance to not overexpose yourself to impulse investments and high-risk purchases because you feel the market is low. You may also need to avoid the ‘herding’ trait which is ‘everyone else is buying this stock so I need to get in now whilst its low’.
To summarise, try to identify your investment composure level and then understand how and why you feel as you do during difficult times. More importantly, try to avoid the actions and traits that the composure levels make you feel like acting upon . Investing is for the long term as markets always go up over time and are more predictable the longer the time frame. Its not for the short term where volatility and performance is unpredictable.