How to focus on risks to achieve long-term financial goals

By Ranjeet S Mudholkar

The financial services industry has focused primarily on investment returns. There is an inherent urge among fund managers to outperform the competition and the chosen benchmarks. This has seemed to trickle down in the investment psychology of investors who have got into the habit of focusing on potential gains from investing while ignoring what they might stand to lose in the bargain.

It is the level of risk exposure in an investment proposition that investors do not fully understand. What investors are led to understand as risk is rather a vague labeling of investments mostly on their potentiality to deliver returns based on their past experience.

They are risk-rated and are assessed at one particular point in time, which does not necessarily reflect the level of risk in the past or that which is likely to occur in the future. Risk-targeted portfolios on the other hand, are managed on a forward-looking, tactical basis to ensure that the level of risk inherent within the portfolio will always be compatible with the risk profile of the client.

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A recent consumer survey of 2,067 people conducted by YouGov for Skandia Investment Group in the United Kingdom showed that half the people questioned who have an investment product were only vaguely aware of the level of risk within that product.

A further 8 percent of people said they had no understanding at all, with only 42 percent saying they understood in detail the level of risk being taken. So a majority of people who invest in a fund thinking that the fund matched their risk profile get a rude shock on the happening of a risk event when the actual return profile of the fund behaves at its extremity and the actual performance falls outside their expectations.

The solution is to combine risk-profiling tools with risk-targeted funds. In other words, get the client to agree to a level of risk as per her calibrated risk profile and then match an investment solution to this, mostly the solution does not come in the form of a straight jacket equity or debt fund but in an asset allocation which can be tactically managed primarily from a risk angle to generate the required returns.

The volatility seen in the past few years across all markets: Equity, Bonds, Foreign Exchange, Commodities has brought increased focus on managing this aspect alongside other factors such as costs, investment returns and tax. The investment solution therefore replaces investment products in the overriding theme of managing volatility or investment risk while delivering the best possible investment return for that level of risk.

This is all the more reason for the clients to remain invested through the market volatility and all market cycles in order to achieve their financial goals. This is also the crux of Financial Planning activity which is client centric, and is for long term so that all life goals of a household are achieved, wealth is created and passed on to the next generation. As an instance of risk-targeting, a 9 percent per annum tax-adjusted return which suits a client’s risk profile through the life stages is achieved by a managed asset allocation which delivers this return on a consistent basis, instead of hunting for investment products, either solely or in combination, which are supposed to deliver such a return.

Hence, if you are a lay investor, approaching a certified financial planner (CFP) professional makes sense. A CFP gathers all quantitative and qualitative information from a client and through modern techniques of risk profiling arrives at a level of risk at which an investment solution could be developed. This risk-targeted mechanism implemented and managed in a tactical fashion delivers optimum returns to achieve a client’s financial and life goals.

Ranjeet S Mudholkar, is Vice Chairman and Chief Executive Officer, Financial Planning Standards Board India (FPSB India). The views expressed here are personal, and do not necessarily represent that of the organization.