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Advisers should discuss loss capacity

It has drawn up a list of five top tips for advisers to consider when talking about the capacity for loss.

Firstly, capacity for loss should be considered as a distinct part of the factfind process, separately to attitude to risk.

Secondly, advisers should consider non-financial issues such as lifestyle and wellbeing, which may also affect a client’s propensity to withstand losses.

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Cashflow planning is another good way of demonstrating to consumers the effect of losses on their future financial situation.

Fourthly, capacity for loss should be reviewed on a regular basis in the same way that attitude to risk is regularly considered.

Finally, advisers hsould include specific reference to capacity for loss within any client correspondence relating to the client’s investment choices.

Research conducted by Architas found that nearly half, or 44 per cent, of advisers think the FSA’s guidelines around capacity for loss need more clarification. A further 24 per cent find them confusing and would cover this topic under “appetite for risk”, even though the two are considered separate and should be treated as such.

“Capacity for loss” has been defined by the FSA as “the customer’s ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk that they are able to take.”

Caspar Rock, chief investment officer of Architas said: “From our research and our dealings with advisers, it is clear that more needs to be done with research for capacity for loss. The FSA has 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 persperctive.

“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.”

Key points:

Financial advisers should hold specific discussions with clients on the capacity for loss when carrying out suitability assessments with their clients

capacity for loss should be considered as a distinct part of the factfind process

44 per cent, of advisers think the FSA’s guidelines around capacity for loss need more clarification

Nick McBreen, IFA of Worldwide Financial Planning, said overemphasis on ‘capacity for loss’ “could abrogate the responsibility, and [advisers could] say ‘We will put it into a risk rated fund. That’s not the point, you’ve got to look at the downside. If the advisers are driven by the regulatory framework, most people are going to end up with this vanilla flavour portfolio, where they are erring on the side of caution and are missing out on investment opportunities.