7 Important Risks to Manage for Clients
Risk management is not a focal point of discussion. For clients, the conversation is always about the hot topics such as stocks, real estate and investment opportunities.
But managing risks is probably the most important thing to do. As what many successful traders say: ” Take care of the downside, and the upside will come.”
Take care of the downside, and the upside will come
So what are the important risks to manage for clients?
No. 1 Liquidity Risks
Buying properties is a major decision for most people. Unfortunately, they don’t ask some of the most important questions:
- Are you able to sell whenever you want to?
- Would there be many buyers or few buyers?
- What is the lowest price you have to quote to attract a buyer, when there is no buyer?
- How long does it take for you to receive the cash?
- What is the cost of the transaction?
This is liquidity risk. It is present in all investments such as stocks, bonds, foreign exchange, businesses, cars and watches.
Liquidity risk is not only about investments. It is also related to budgeting and cashflow. If you place your money in a fixed deposit for 12 months, would you be able to withdraw the money anytime for use. Can you take the money out on a Saturday afternoon to buy the expensive watch or downpayment for a car?
More on liquidity risks:
- What is the amount a client can get without a substantial loss today, tomorrow or in the near future?
- How much cash can he get if he sells everything today?
- When can he get the money back?
Fortunately, most people wouldn’t need to sell it. But when there is an urgent need or when emergency strikes, a good wealth management plan already covers this risk.
No. 2 Insurable Risks
Most clients associate insurance with death, illness and accidents. These are covered through life and health insurance plans. Car accidents, fire and travel accidents are covered through general insurance plans. These protect clients from common, unpredictable and unwanted risks / expenses for a small fee.
Insurance becomes more valuable when it impacts people’s work. For example, Mariah Carey legs were reportedly insured for $1 billion while David Beckham famous legs are insured for £100 million when he was playing for Paris Saint Germain.
In businesses and companies, key-man insurance protects the company and shareholders in the event of loss of the most important person(s) that is critical to the company success. Example, if Albert Einstein was working in your company, the loss of his possible inventions could be catastrophic to the future of your clients’ company. A key-man insurance policy could reduce the near-term financial impact.
Notable Celebrities Insurance Coverage:
|Mariah Carey||Legs||$1 billion|
|David Beckham||Both Legs||£100 million|
|Christiano Ronaldo||Both Legs||£74million|
|Taylor Swift||Both Legs||£26.5 million|
|Julia Roberts||Smile||$30 million|
|Daniel Craig||Body||$9.5 million|
|Rod Steward||Voice||$6 million|
|Kylie Minogue||Buttock||$5 million|
Credits: Lloyds Insurance, Forbes
No. 3 Financial Market & Investment Risks
The financial market is a love-hate affair. With economic growth comes economic downturn. With possibly better returns, it comes with associated risks such as capital losses and poor returns.
Wealth Managers and Investment Professionals work hard to diversify financial risks for clients. They use techniques such as modern portfolio theory, asset allocation strategy and dollar-cost averaging.
To protect from an unpredictable financial market, wealth managers employ the use of financial derivatives such as options, forwards, swaps and futures to manage, protect or grow their client’s portfolio.
Some common ways to protect short-term volatility on a $1 Million equity portfolio:
- Buy 3 Months put options on equity index
- Short equity index futures
- Long volatility index
- Long futures on safe asset classes (Treasury bills, Government bonds, Gold etc)
How businesses use financial derivatives:
- Buy FX forwards to hedge future cost / revenue of different currencies
- An oil producing company sell oil futures contract to hedge future profits
- A property developer with large loan books buy interest rate-swap to protect against rising interest rates
- A supplier to a global MNC (with 90 days payment terms) buy credit-default swap on the MNC in case of default.
No. 4 Credit Risk
Credit risk is the biggest business of banks and finance companies. Between banks to banks (interbank), they have a limit on lending and business to each other by using different providers, not only for competitive pricing but to diversify risks.
For clients, they are usually powerless when financial institutions change credit policies and stop lending to them. Sometimes, for undisclosed reasons, their credit risks goes up and their loan rates rises. Other times, the amount of loan available to them decreases.
- European Bank for Reconstruction and Development stop lending to Russia in 2014
- Housing investors in Australia face crackdown as banks exceed regulator’s lending limit
When the credit risk becomes too large for the banking & financial system, it can be classified as systemic risk.
No. 5 Risk of Fraud, Scams
Bad investments, getting cheated, going into get-rich scams, Ponzi schemes and more, clients are always vulnerable to these fraud risks.
Just when you think that the financial industry is well protected, you recall the collapse of Lehman Brothers, and names such as Howie Hubler who lost USD 9 billion with Morgan Stanley in 2008, Jerome Kerviel losing USD 7.22 billion with Societe Generale in 2008. Learn More: 20 Traders who lost more than a billion
- NBA star Tim Duncan lost more than $20 million from dishonest financial advisor
- Ex-relationship manager gets 11 months for cheating bank customers
- Former Private Banker Jailed for cheating bank of $2.5m with fake signatures
No. 6 Legacy & Estate Risks
Building wealth is easy: Work, earn and save. Between age 25 to 65 is the age band where most people work and accumulate their wealth. They may have thought about who to pass the money to in an “ideal” situation, but mishaps happen:
- Your clients become physically or mentally incapable of managing their money?
- How about receiving a sudden inheritance from their parents or relatives? What do they do?
- What if they pass on and leave behind a young child and a non-working spouse?
- Do they have cashflow for loan & expenditure obligations before they receive the estate?
- Are their bank accounts in a legally accessible setup?
These are risks most people don’t think it is important. It further complicates their risks if they had invested into non-liquid or non-listed investments such as commercial properties, luxury items, businesses, overseas assets or investment schemes.
- Would there be tax issues?
- How long would the transfer of estate take?
- Who would be the contact person?
Legacy and estate risks are important risks to manage. Sometimes, the cost can be huge.
No. 7 Legal Risk
Everyone tries to avoid the law, but legal risk is of growing importance in wealth management. When it comes to inheritance, a will doesn’t necessary make things easier, especially when the amount involved is large.
- Yeo Hiap Seng descendants in tussle over will
- Samsung boss Lee Kun-hee wins US$4b in inheritance row
- Malaysian ex-beauty queen fights to divorce billionaire husband in London court
How about when investment goes wrong? Would there be restitution or a chance of recovery? Or tax issues that arise?
- Dinner with Goldman Sachs cost him $34 million
- German court allows investors to sue S&P over Lehman
- Wine fraudster Rudy Kurniawan gets 10 years in jail
- IRS entices U.S. expats to come clean on back taxes with relaxed rules
- Football star Lionel Messi in tax charge
These are 7 important risks to manage for clients. Does your wealth management plan cover all these risks? Would the advice be valuable to clients?
- 5 Reasons why wealth management is harder in low-tax countries
- 8 Reasons why Wealth Management has become important in Capital Markets
- How do you manage clients during financial crisis & market downturn?