Your Capacity for Loss

One of the more difficult aspects of financial planning is the subject of capacity for loss. In essence this attempt to assess how bad things need to be before your lifestyle is significantly worsened. Most think in terms of the decline of a portfolio due to stockmarket crash, which would also affect the level of income that could be withdrawn from it sustainably.

Your appetite for risk, (or risk tolerance) is normally tested using a psychometric tool, such as the one we use (FinaMetrica) is different – testing your ability to cope with the shift in value of your portfolio (or volatility). All tools are flawed and in reality, it isn’t a process for generating an answer, more of a helpful starting point in a discussion. Capacity for loss has more to do with your financial ability to cope with loss.

A financial planners job is to attempt to ensure that your money lasts a little longer than you do. Yes its more complicated than that in practice, but if you strip away the mechanics and maths, that’s invariably where it leads.

What you have to lose

However, putting a number on this is arguably an impossible task. There are lots of relevant variables. Your age, investment timeframe, years until you retire, health, family commitments, income and expenditure, net worth, cash reserves, debt and insurance and of course this is all a moving continuum. Many clients will at some point say that they will live within their means, to cut their cloth accordingly, which of course is a sensible approach to the restrictions of real life.  However, in practice this can hurt, and it’s easier to blame someone else for discomfort, that it seems, is what our political system is all about.

Why capacity for loss is an issue

I assume (which is therefore prone to error) that the regulator is concerned about capacity for loss, because it would appear that over the years there have been many investors that simply didn’t understand what they had invested in and it would seem did not understand how the impact of an investment going wrong might impact them. Neither did they understand the illustrations. I would suggest that this is in part due to a lack of financial education, a lack of adviser explanation and frankly a lack of interest.

We live in a world of risk

The truth is that investing carries risk, but then so does not investing, just a different one, which can be equally as painful. In real terms, by which I mean once you allow for inflation, many people’s income has reduced over the last few years. Inflation, currently very low can ravage away at the power of the money you hold. So, holding cash, which is currently generating less than inflation each year is essentially going backwards.

There is always somewhere to be King…

By historical standards we are all rich, by global standards we are all rich, but you may not feel it.  Indeed, to be richer, or certainly feel richer, simply encash your worldly wealth and move to somewhere that is obviously poor, there you can live like a king…. Isolated, needing high castle walls and compelled to spend huge sums on defending what you have. Rich, but perhaps not connected.

The roaring Lion

May I suggest an alternative? Perhaps pay a trip to the cinema to see Lion. This is the true story of how a small boy from a very poor village in India, gets lost and is eventually adopted by an incredible Australian couple. His life takes a very different path but eventually leads to a search for the family he lost.

Keep in mind the 767 million

We all know that most of the world is poor by our standards, and we are told that things are gradually improving, fewer people are in poverty, in 2013 10.7% of the world live on less than $1.90 a day. In the previous year, it was 12.4% (World Bank). That’s still 767million people, but 35% less than in 1990.

None of this is news to you. Yet I found myself confounded and discomforted once again by the plight of millions living in poverty and vulnerable children, who live on the streets and experience all sorts of abuse. I came away with a mixture of feelings, grateful that I don’t live in such circumstances, perplexed at why Governments don’t do more to serve their own people well and perhaps too a little ashamed of my own lifestyle choices, when so many have so few. So, I do wonder if it is ever truly possible to be even vaguely precise with terms like capacity for loss in a world of such extremes.

As for the film, it is very much worth watching and its good to see Dev Patel has been nominated for some awards along with the film. Here is the trailer.

Dominic Thomas
Solomons IFA

You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email