Calculating Suitable Risk

Combining Risk Tolerance and Risk Capacity 

Adjusting Risk Tolerance for Risk Capacity is simple: all we have to do is multiply the scores together. 

For example, if a client’s Risk Tolerance is Medium on a five-point scale – i.e. 3 out of 5 – and they have a Risk Capacity score of 1.0, then their provisional Suitable Risk Level is: 

3 x 1.0=3

If instead the Risk Capacity score was 1.3, then their Suitable Risk Level would be: 

3 x 1.3=3.9

which would be rounded to 4, i.e. Medium-High risk. 

This simple calculation works because, when Risk Capacity is high, the extra risk taken in the investment portfolio is diluted by the remaining, non-invested wealth.  

Conversely, when Risk Capacity is low, the investment portfolio takes on less risk, because it is effectively dialled-up relative to the investor’s overall wealth. 

In both cases, the risk of the investment portfolio is calibrated so that the risk of the investor’s overall wealth is in harmony with their Risk Tolerance. 

The effect of Composure 

Even if an investor has ample capacity to increase the risk of their investment portfolio, it doesn’t mean they always should. Some people might not have the emotional reserves to stomach it. 

So, any increases in Suitable Risk due to high Risk Capacity is diluted for investors with low Composure by 50%; for investors with Medium Composure it is diluted by 25%. 

The effect of Knowledge & Experience 

The effect of an investor’s K&E rating is as follows:

K&E rating	Effect on Suitable Risk Level
	Non-pension	Pension
High	-	-
Medium	Reduce by 1 level	-
Low	Reduce by 2 levels	Reduce by 1 level

Separate Suitable Risk Levels for pension/non-pension assets are unavailable when using Simplified Risk Capacity. 

Accounting for externally-held assets 

Sometimes an investor will hold investible assets externally, which you may not have any control over. If these portfolios are not invested at their Suitable Risk Level, then it might be necessary to make a balancing adjustment to the recommended risk. 

Suitability Compass will automatically work out how much risk investors should take with the portfolio under consideration so that their aggregated investment portfolio - including external assets – matches their Suitable Risk Level. 

Investors can make this possible by providing high-level details of the nature of such portfolios (i.e. roughly how much is in cash, bonds, equities etc.) as part of the Financial Circumstances fact-find. 

Accounting for externally-held assets is not applicable when using Simplified Risk Capacity.