Investor Compass blends objective finances with behavioural insight so you can recommend strategies that are both emotionally and financially suitable.
This short guide explains:
- What Risk Capacity is – and isn’t
- How the Financial Circumstances module captures the data behind it
- How Investor Compass turns those data into a Risk Capacity score that feeds the client’s Suitable Risk Level (SRL)
- How Risk Capacity Fine-Tunes the Suitable Risk Level – and How Other Factors Cap It
- Best-practice tips for advisers
▸ What is Risk Capacity?
|
Concept |
One-line definition |
Key point |
|
Risk Capacity |
A client’s financial ability to take investment risk over time |
It’s about ability, not feelings |
|
Risk Tolerance |
A personality trait: how much risk the client is willing to take to improve long-run outcomes; defined over their total wealth position |
Stable, psychometric; measured by the Financial Personality Assessment (FPA) |
|
Capacity for Loss |
Ability to withstand a fall in portfolio value without harming lifestyle today |
Investor Compass embeds this within the wider Risk Capacity calculation. Capacity for Loss is directionally limited—i.e. it only reduces suitable risk, whereas Risk Capacity can adjust it up or down.
|
The FCA’s suitability rules (COBS 9A / PROD 3 / Consumer Duty) require firms to assess both risk tolerance and “the client’s capacity for loss or ability to bear losses.” Investor Compass covers both: Risk Tolerance via the Financial Personality Assessment (FPA) and Capacity for Loss inside the broader, forward-looking Risk Capacity model.
▸ What counts as ‘Financial Circumstances’?
|
Category |
Typical items captured |
|
Assets |
Cash, ISAs, GIAs, pensions, main residence, rental properties, collectables |
|
Liabilities |
Mortgages, personal loans, credit cards, tax bills |
|
Income |
Salary, self-employment, rental income, pensions, maintenance |
|
Expenditure & Goals |
Regular living costs, upcoming school fees, weddings, lump-sum gifts, retirement spending plans |
Data entry takes roughly 3–5 minutes. Start with ball-park figures; refine later – Investor Compass updates instantly.
▸ How Investor Compass calculates Risk Capacity
- Cash-equivalent Net Wealth: Adds assets, subtracts liabilities; applies “hair-cuts” for illiquidity & emotional attachment (e.g. main home).
- Future Flows Adjustment: Discounts future income and spending for timing, certainty, and flexibility (essential vs discretionary).
- Goal-priority Weighting: Higher-priority, nearer-term goals reduce capacity more.
- Capacity Score: Outputs a number (with 0 being no risk capacity, 1 “neutral”, and >1 high) that feeds the SRL algorithm.
High-RC illustration: • Owns mortgage-free home • Stable surplus income • Low short-term liabilities
Low-RC illustration: • Large mortgage & upcoming school-fee goal • Income uncertain
▸ How Risk Capacity Fine-Tunes the Suitable Risk Level – and How Other Factors Cap It
Risk Tolerance (RT) is anchored to total wealth: it says, “Given everything I own, this is the risk I’m willing to take to grow my wealth in the long-term.”
Risk Capacity (RC) then asks, “Given how that total wealth is split between liquid investments and harder-to-use assets (home, future earnings, liabilities, goals), how should the risk on the investible slice be set so that overall wealth actually sits at the RT level?”
|
Scenario |
Logic |
Resulting SRL adjustment |
|
High RC |
Non-investment assets (e.g. mortgage-free home, surplus income) act as a buffer. If the investible portfolio were left at the RT level, total wealth would sit below the risk the client is happy to bear. |
Portfolio risk is increased (sometimes above the RT band for assets alone) so that overall wealth aligns exactly with RT. |
|
Low RC |
Heavy liabilities, lumpy income, or near-term goals make the client heavily reliant on their portfolio. If the portfolio took RT-level risk, total wealth would be over-exposed. |
Portfolio risk is dialled down until total risk exposure once again matches RT. |
RC tilts the risk taken on investible assets so the entire balance-sheet ends up precisely where the client’s long-term preference (RT) says it should be.
Behavioural Capacity and K&E: When Extra “Brakes” Apply
After RC has adjusted the dial, two further checks can cap the final Suitable Risk Level (SRL):
|
Cap |
Why it matters |
Typical effect |
|
Behavioural Capacity (Composure) |
Clients with low Composure are prone to anxiety in downturns. Exposing them to higher volatility than they can stomach risks bad decisions. |
SRL is limited to keep portfolio swings within an emotionally bearable range. |
|
Knowledge & Experience (K&E) |
New or inexperienced investors may not fully understand what they are buying. Regulation (and good practice) says “start lower while they learn.” |
SRL may start conservatively, then rise as K&E improves (often reviewed annually). |
▸ Adviser best-practice checklist
- Use the client-friendly report to explain how RC fine-tunes portfolio risk and why Behavioural/K&E caps may still apply.
- Review Financial Circumstances at least annually (or sooner after major life events).
- Re-run the FPA less frequently—every 2-3 years—because traits such as Risk Tolerance and Composure only evolve slowly.
- Encourage clients to answer FPA items quickly and intuitively; there are no “right” answers, only honest ones, and quick, intuitive responses give the most accurate results.
- Capture full financial circumstances: assets, liabilities, income, spending, and future goals.