Navigating Capacity for Loss: Key Insights for Savvy Paraplanners
One common misconception in the paraplanning world is the belief that attitude to risk takes precedence over capacity for loss, when, in reality, it’s often the other way around. Understanding a client’s financial ability to absorb losses is paramount, and here are five crucial points to consider when assessing capacity for loss:
1. FCA Mandate on Capacity for Loss
In March 2021, the Financial Conduct Authority (FCA) emphasised the importance of considering capacity for loss in suitability reports. The FCA defines it as the customer’s ability to absorb falls in the value of their investment, especially if it would materially impact their standard of living. This underscores the need for a thorough assessment beyond just attitude to risk.
2. Factors Influencing Capacity for Loss
Assessing capacity for loss requires a comprehensive look at various financial aspects:
– Income needs
– Present and future income sources
– Other assets
– Expected inheritances
– Time horizon before investment withdrawal
Documenting these details in the fact-find is essential for a holistic understanding.
3. Distinguishing Between Types of Losses
Paraplanners should differentiate between permanent and temporary losses. Understanding whether a client can recover from a loss over time is crucial. This nuanced evaluation ensures tailored recommendations based on the specific nature of potential losses.
4. Integration of Attitude to Risk and Capacity for Loss
While distinct, attitude to risk and capacity for loss should be assessed together. For instance, a client expressing a willingness to take high risks but having a low capacity for loss implies that the latter will dictate recommended solutions. This integrated approach provides a balanced view of the client’s financial landscape.
5. Precision with Cashflow Modelling
There’s no one-size-fits-all method for assessing capacity for loss, but cashflow modelling stands out for its precision. Calculating losses in percentage terms and aligning them with a client’s cashflow forecast provides a tangible understanding. Additionally, capacity for loss questionnaires and examining income requirements can offer valuable insights.
Tony’s thoughts
I see many examples of capacity for loss only given a cursory nod by advisers with the product selection and tax tail wagging the recommendations. If someone does not have three to six months of available cash to cover income or sufficient cash to cover known expenditure (holidays, car purchase, home improvements etc.) in the next 12 months then quite simply they should not be investing for five years plus! My other bug bear is the immediate use of pensions due to the tax relief available rather than a sensible use of say ISAs to provide a level of medium term cash needs, given that pension fund access could be decades away.
Top Tip: Prioritise Capacity for Loss
As Hannah suggests place capacity for loss as the primary decision-maker, superseding attitude to investment risk. This approach ensures a solid foundation for crafting well-informed and client-centric recommendations.
**Get in Touch**
If you want to delve deeper into capacity for loss discussions or ensure the robustness of your suitability reports, reach out to us at hello@wecomplement.co.uk or call 01472 728 030.
Navigate capacity for loss wisely, and let’s elevate the standard of financial planning together! 🚀💡 #Paraplanning #FinancialAdvice #CapacityForLoss #FCAGuidance #InvestmentRisk