Financial advisers are being urged to conduct specific discussions on capacity for loss when carrying out investment suitability assessments with clients. The conclusions should also be recorded and communicated to clients. However, research* conducted on behalf of Architas found that nearly half (44%) of advisers think the FSA’s guidelines around capacity for loss need more clarification. A further 24% find them confusing and would cover this topic under ‘appetite for risk’, when there is clear guidance that the two should be treated and evaluated separately as they are distinct issues.
On the back of these findings, Architas has drawn up five top tips for advisers to consider when discussing capacity for loss with clients:
1. Capacity for loss should be considered as a distinct part of the fact find process, separately to attitude to risk
2. Advisers should consider non-financial issues such as lifestyle and wellbeing, which may also impact a client’s propensity to withstand losses
3. Cashflow planning is a good way of demonstrating to consumers the effect of losses on their future financial situation
4. Capacity for loss should be reviewed on a regular basis in the same way that attitude to risk is regularly considered
5. Advisers should include specific reference to capacity for loss within any client correspondence regarding the client’s investment choices.
Caspar Rock, chief investment officer, Architas, said: “From our research and our dealings with advisers, it is clear that more needs to be done with respect to capacity for loss. The FSA have identified it as an area of interest to them, but it has not offered evidence of best practice as to how it should be documented or presented from a compliance perspective. Our intention is to draw attention to this area of investment suitability, and ensure that advisers are better equipped to discuss this with clients.
“Creating a tool will not be easy due to the large number of potential factors that may have an impact on a particular individual, but cash flow models, such as those available via Elevate, are a good starting point. It would also be wise to outline those factors that may have an impact on capacity for loss for discussion with clients.”
Mark Pentelow, chief executive, Pacific IFA, who was part of the discussion, added: “Capacity for loss is a difficult area, but there are tools that allow us to demonstrate to clients, on a very high level, the potential impact of a loss on their investment. In addition, there are also a number of issues that advisers should go through with their clients. This includes the different pots of money they have and what they are for. If you have £40,000 for children’s school or university fees your approach, and how you view loss, is very different to if that is ‘spare’ money.”
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