Agenda

Week 1 - Risk, Volatility & Timescale

Week 2 - Asset Allocation

Week 3 - Identifying the Building Blocks

Week 4 - Reviewing a portfolio

Risk, Volatility & Timescale

Key Risks

Inflation Risk - Reduction in buying power of money

Longevity Risk - Risk that you’ll outlive your money

Inertia Risk - Risk that you’ll miss out by doing nothing

Investment Risk - Risk of financial loss due to markets or provider failure

Key RisksInflation Risk - Reduction in buying power of money

£

5% Growth

Key RisksInflation Risk - Reduction in buying power of money

£

3% inflation

2% Net Growth

Fix: Invest to grow ahead of inflation

Key RisksLongevity Risk - Risk that you’ll outlive your money

Key RisksInertia Risk - Risk that you’ll miss out by doing nothing

Start February April June August October December

Investment Risk

Definition Chance that an investment’s actual return will be

different than expected. Risk includes the possibility of losing some or all

of the original investment

100% chance of investment risk!

Investment RiskRisk of provider failure?

• Always possible - remember Lehman Brothers• Major provider unlikely to be allowed to fail• Only way to be sure: < £50,000 FSCS limit• Know where your money is held

★ 3rd party nominee?★ Own nominee?★ Will be separate from operating expenses of

provider

Investment Risk

Markets

Investment RiskIMPORTANT

If the value of an asset you hold is reduced, this does NOT constitute a loss.

A loss is only experienced when you sell the asset

Investment Risk

Investment Risk

Investment Risk

Investment Risk

Investment Risk

How much can you afford to lose?

Risk Tolerance &

Capacity for Loss

Risk ToleranceYour ability to cope with financial shocksMore about emotional response than your

financial capacityCan you disregard external input?

At what point will you start to worry?At what point will you bail out of the markets and

crystallise your losses?

Risk ToleranceYour ability to cope with financial shocks

Risk ToleranceYour ability to cope with financial shocks

Relative ability to cope is irrelevantRisk is an abstract concept

Real money and real life matterCheck out

meaningfulmoney.tv/myrisktolerance

Capacity for LossHow much can you afford to lose?

Remember loss is only on crystallisationNo-one loses ALL their money, unless taking big

betsHow much are you investing relative to total

wealth?

Capacity for LossHow much can you afford to lose?

Total liquid wealth: £250,000 Amount to invest: £25,000 = 10% of total

50% loss on that = £12,500 Which equals 5% of total wealth

Capacity for LossHow much can you afford to lose?

Total liquid wealth: £250,000 Amount to invest: £200,000 = 80% of total

50% loss on that = £100,000 Which equals 40% of total wealth

Cautious Moderately Cautious Balanced Moderately

Adventurous Adventurous

Expected Return 4% 5% 6% 7% 8%

Max expected 1yr Gain

14% 17% 24% 32% 36%

Max expected 1yr Loss

-4% -6% -10% -14% -17%

90% certainty - as good as it gets!

Capacity for Loss

1 Year Balanced £100k invested

Expected Return 6% £106,000

Max expected 1yr Gain 24% £124,000

Max expected 1yr Loss -10% £90,000

Capacity for Loss

3 Years Balanced £100k invested

Expected Return 6% £119,101

Max expected 1yr Gain 24% £190,000

Max expected 1yr Loss -10% £72,900

Capacity for Loss

Capacity for Loss

This should help you to answer the questions: • How much fluctuation am I happy with? • How much can I afford to lose?

Timescale & Risk

Timescale & RiskAccumulation Phase

Timescale Risk Level

< 4 Years Risk-free

4 - 5 Years Risk Profile minus one notch

5 - 10 Years Risk Profile

> 10 Years Risk Profile plus one notch

Timescale & RiskAccumulation Phase - Balanced Investor

Timescale Risk Level

< 4 Years Risk-free

4 - 5 Years Moderately Cautious

5 - 10 Years Balanced

> 10 Years Moderately Adventurous

5 Year investment: Moderately Cautious

8 Year investment: Balanced

20 Year investment: Moderately Adventurous

Timescale & RiskDecumulation Phase

Timescale Risk Level

< 2 Years Risk-free

2 - 4 Years Risk Profile minus one notch

4 - 8 Years Risk Profile

> 8 Years Risk Profile plus one notch

Money you’ll never need Take your pick

Timescale & RiskSegmentation

Accumulation DecumulationTimescale Risk Rating Timescale Risk Rating

< 2 Years Risk-free < 2 Years Risk-free

2 - 4 Years Risk-free 2 - 4 Years Risk Profile - 1

4 - 5 Years Risk Profile - 1 4 - 8 Years Risk Profile

5 - 10 Years Risk Profile > 8 Years Risk Profile + 1

> 10 Years Risk Profile + 1 Money you’ll never need Take your pick!

Timescale & RiskDecumulation Phase

Essential not to take too little risk in the decumulation phase.

Traditional Lifestyling is not fit for purpose

Exception: Annuitisation

Timescale & RiskSegmentation - Example

Savings for Christmas, holiday, new car - zero risk (<1-2 years)

Saving for daughters’ university costs - balanced risk (Begins in 2.5 years for possibly 6-8 years)

Retirement Savings - adventurous risk (>15 years)

Timescale & RiskSegmentation

Most of us don’t have lots of different target potsEasy to segment using wrappers

Or segment using investment choicesOnline platforms make things easy

Risk Measures

Risk MeasuresVolatility

Definition: How much a fund deviates from its average

Problem: Calculation methods not always obvious

Simple exampleAverage return: 5%

Volatility = 15Range = -10% to +20%

Risk MeasuresVolatility

Definition: How much a fund deviates from its average

Problem: Calculation methods not always obvious

Another simple exampleAverage return: 5%

Volatility = 5Range = 0% to +10%

Not a great measure, but nominally useful

Risk MeasuresSharpe Ratio

Definition: Amount of excess return per unit of risk

Excess return? Over risk-free rate, eg cash or govt bonds

No good or bad Sharpe ratio; it’s a comparison

Higher is better

Negative Sharpe = better off in cash!

Risk MeasuresSharpe Ratio

Risk MeasuresSharpe Ratio

Two funds: Fund A & Fund B

Fund B has higher Sharpe Ratio

Fund B has has achieved higher return, while taking no more risk than Fund A

SummaryDifferent kinds of risks

Investment risk - when is a loss not a loss?

What matters is when you need the money

Risk tolerance & Capacity for loss

Timescale & Risk

Risk Measures for fund choice

Timescale & RiskSegmentation

Accumulation DecumulationTimescale Risk Rating Timescale Risk Rating

< 2 Years Risk-free < 2 Years Risk-free

2 - 4 Years Risk-free 2 - 4 Years Risk Profile - 1

4 - 5 Years Risk Profile - 1 4 - 8 Years Risk Profile

5 - 10 Years Risk Profile > 8 Years Risk Profile + 1

> 10 Years Risk Profile + 1 Money you’ll never need Take your pick!