Financial Circumstances Intruduction

The Financial Circumstances Assessment calculates investors’ Risk Capacity – their financial ability to take risk. 

Risk Capacity compares the size of investors Total Net Wealth to the size of their Investible Assets and is used to determine whether to increase or reduce the Suitable Risk Level (also known as Risk level on our API documentation), relative to Risk Tolerance. 

Risk Capacity=Total Net Wealth Investible Assets Risk Capacity=Total Net Wealth Investible Assets

If Total Net Wealth is large compared to Investible Assets then Risk Capacity is High and if Total Net Wealth is smaller than Investible Assets, Risk Capacity is Low. 

Total Net Wealth =Net Investible Assets +Net Non-investible Assets + Net Future Cashflows. 

Higher levels of risk capacity come from two sources – 1) positive Non Investible Assets (e.g. property less debts) and / or 2) positive Future Cashflows (e.g. income less expenditure). In other words the investor is in accumulation.

Lower levels of Risk Capacity occur where the investor’s debts are larger than their Non Investible Assets (i.e. they are in negative equity) and / or more likely when their expenditure exceeds their income (i.e. they are in drawdown). 

Investible Assets are those assets which the investor is prepared to invest at their Suitable Risk Level to meet future spending plans and goals and includes cash, investments and pensions. 

Some Investible Assets may be held else where and Investor Compass can work out the right level of risk to take with the Investible Assets you do have control over, to balance out the risk of externally-held portfolios.

Net Non-investible Assets are assets which the investor cannot invest in a diversified portfolio, such as properties, businesses assets, cars, art and other chattels. They should be adjusted to account for any debts 

When providing Non-investible Asset details, investors can indicate their willingness to sell them to fund spending. Higher levels of willingness will increase the Risk Capacity score. This is only an approximation, because it is very hard to put a number on willingness – and we believe it is better to be roughly right than precisely wrong.

Net Future Cashflows (income less spending) are also considered as part of an investor’s overall wealth. This is related to the notion of “human capital”: young people have considerable expected future income, part of which will be used as contributions to their pensions. In the early stages of their careers, their pension pots are very small relative to their future size, and therefore should be invested at a high level of risk.

But because the future is highly uncertain, we incorporate a progressively stronger dampening effect on these cashflows. This is to ensure that Risk Capacity is considerably less influenced by income or expenditure anticipated more than five years hence.

When providing details of expected future income, investors can indicate roughly how certain they are that it will happen. Higher certainty of income increases Risk Capacity and higher certainty of spending decreases Risk Capacity 

Similarly, investors can specify how flexible they are about planned expenditures, and their importance. These approximations are used by Investor Compass to reflect investor perceptions about future cashflows in their overall Risk Capacity, without attempting to be spuriously precise about every detail.

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