As we are all aware, the value of investments can go down as well as up, and investors need to accept the possibility that they might see falls in the value of their portfolios, and to consider whether they can financially and psychologically accept that.

Some people have a robust attitude to risk, but others do not, as Ryan Medlock, senior investment development and technical manager at Royal London, says: “There will be some who will be very uncomfortable at the idea of volatility and the chance of losses within their investments, whereas others will be more relaxed.”

Capacity for loss is defined by the Financial Conduct Authority as “the customer’s ability to absorb falls in the value of their investment” and stipulates that if loss of capital would adversely affect their standard of living, this should be taken into account when assessing how much risk they are able to take.

It is therefore important that clients fully understand attitude to risk and capacity for loss when managing their pension savings.

Jonathan Cooper, head of paraplanning at Drewberry, says: “Pension savers need to be aware that attitude to risk and capacity for loss are two different things. Risk attitude is about how they feel about investment risk, whereas capacity for loss is about how much risk they can afford to take. These concepts need to be delineated and considered alongside clearly defined retirement goals.”

He adds: “Both are equally important parts of the broader risk discussion – just because someone feels that they want to take risk does not mean that they have the financial resources and stability to make it a good idea.”

Medlock also emphasises the difference between the two concepts: “Simply put, attitude to risk (and its cousin tolerance for loss) are more to do with an individual’s psychology, whereas capacity for loss is more to do with their financial circumstances and investment goals.”

To objectively consider and understand one’s own capacity for loss, detailed information about likely sources of income and expenditure plans in retirement is required. This is why a good Independent Financial Adviser will ask you lots of questions, not just about your pension pots but about your finances more generally and will dig deep into your hopes, needs and concerns.

Gavin Jobson-Wood, specialist business development manager at Scottish Widows, says: “The implications of making inappropriate retirement income choices are clearly very serious and any assessment should consider the impact of a reduction in income, which can help influence the level of risk an individual feels they can take, and how secure their overall income needs to be.

 

There are no one – off decisions

Age is an important factor, emphasises Jon Young, financial planner at WealthFlow: “Attitude to risk and capacity for loss dramatically shift in importance as you age. A young saver has almost 100 per cent capacity for loss; their life is not impacted in any great way by the volatility of investment markets and they have the most valuable asset on their side in the form of time.

“Therefore, for a young saver, their attitude to risk is of far more importance and if they have a low risk appetite, a conversation is needed around possibly stretching the level of risk they are willing to take.

“For someone already retired, or approaching retirement, the inverse is true. Their attitude to risk diminishes in importance, while worrying about the downside and their capacity to handle market volatility increases exponentially. For someone reliant on their drawdown pension income to maintain their standard of living, it would be hard to justify investing in 100 per cent equities or higher risk investments, regardless of their attitude to risk.”

Regular reviews of clients’ attitude to risk, capacity for loss and time horizon are key, says Catriona McCarron, wealth manager at Ascot Wealth Management: “Attitude to risk applies largely to how we invest a client’s pension. Advisers will factor time horizon into these discussions, as naturally an investor’s approach to risk will vary, depending on when they need to access their pension.

“Since the drawdown freedoms of 2015, investors are starting to compartmentalise their pensions more and are feeling more comfortable about taking a pro-risk approach with a portion of their pension that they may not need for income for upwards of 10 years. This therefore stretches their time horizon for drawdown needs as well as in the accumulation stage of retirement savings.

“Pension savers should expect to review their attitude to risk, time horizon and capacity for loss annually, to understand how their objectives have changed. Retirees should be aware that capacity for loss is an important aspect of risk management, and that their asset allocation should be tailored to strengthen their capacity for loss.”

If you would like a review of your pension then speak to your Brooks Wealth adviser.

If we do not currently advise you then please get in touch and we will be happy to conduct a free, no obligation assessment of your retirement planning.

Call 01733 314553 or Email info@brookswealth.co.uk