Are You Sure You Are Managing Risk?

31.10.13

Please note that this article is over six months old. While Blevins Franks takes care to make sure that information is accurate on the date of publication, some content may change over time. You should not rely on the accuracy of legislation and tax information in this article; take professional advice for your circumstances.

One common request we get from investors and retirees discussing their financial planning is that they want to take as little risk as possible.  They understandably want to protect the value of the capital they have built up over the years.

One common request we get from investors and retirees discussing their financial planning is that they want to take as little risk as possible.  They understandably want to protect the value of the capital they have built up over the years.

In many cases they are only thinking about investment risk, and generally just worry about how risky or volatile particular assets are. That is part of it, but not the whole story. First you should identify what your objective is. When we get to retirement most of us want to ensure that our money easily lasts for the rest of our lives so we can maintain the standard of living we are used to – our objective is therefore to maintain our buying power throughout retirement. At the same time, you may wish to leave as much of your wealth to your family as possible.

Wealth preservation is about protecting the value of your capital in ‘real terms’ – that is, after inflation and tax. There are in fact various threats to your wealth that you need to take into account and plan for.

Cash is not the risk free option many people view it as; it depends on your time horizon. If you are retired or nearing retirement and have a life expectancy of 20 years or more, holding all your capital in cash is generally a high risk strategy. The income will be reduced by tax, interest rates can and do change (and are currently at historic lows), and your capital will lose value each year as a result of inflation.

Inflation is insidious – you may not notice the effects each year until it is too late. It is important to consider the impact it can have on your savings now, so you can take steps today to protect your wealth and long-term financial security.

Tax has always been a threat to wealth, more so today. As governments struggle to reduce their debt, they are seeking every opportunity to increase tax revenues. Their main target has been private capital, on which they are imposing higher taxes on income and gains.

If you are a British expatriate, you also need to consider what impact UK inheritance tax will have on the assets you leave to your family and heirs.

In tandem with the tax rises, financial privacy – something which many people once took for granted – is being steadily eroded. Governments across the world are now agreeing to automatically exchange information. This means that tax authorities will receive information on your assets and income abroad each year.

You need to review the way you hold your capital to ensure that is it in the most tax efficient structures for your country of residence, and in a compliant manner so that you need not be concerned about exchange of information.

Another risk we all need to be aware of is institutional risk. This is the risk that the financial institution holding your money will fail. Savers have lost money over recent years as a result of bank failures, and you want to avoid this happening to you.

Within Europe the level of investor protection from institutional failure varies significantly between each country and between the type of institution – e.g. bank, insurance company, investment firm etc. The difference can be significant, so you need to establish exactly what protection all your capital has in the event of institutional failure. Look at the structures you hold your wealth in and ensure your assets are either ring fenced or diversified as much as possible. You can eliminate institutional risk at the same time as improving your tax position.

British expatriates have another risk to consider – currency risk.  Often their savings, investments and pension funds are in Sterling, but living here in the Eurozone all their expenses are in Euros. As you convert Sterling to Euros your income can suffer from exchange rate movements, not to mention the costs involved.

Going back to the original consideration of investment risk, of course assets like equities, bonds and property can fall in value as well as rise, but there are steps you can take to reduce investment risk within your portfolio.

You need to properly diversify your capital across a range of investment assets, countries, sectors and even management styles, to obtain the lowest risk exposure for the potential risk you are seeking. Risk and return are not always proportionate – you can easily expose yourself to more risk than you need to, and more than can be justified by the return potential of your portfolio.

Wealth preservation is perhaps more important than ever before, but in today’s economic environment it is extremely difficult to achieve without the help of professional wealth management advice.

24 September 2013

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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