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Jun 16, 2022
8 min read

Suit yourself - sizing up your investment suitability

“Stick to your long-term investment plan” is good advice under any market conditions. But what precedes that is a thoughtful assessment of your investment style, known as suitability. Do you know how to evaluate yours?

Anna Premyslova joined CWB McLean & Partners’ team in August 2019. As an Associate Portfolio Manager, she has a meticulous approach to portfolio management and is ingenious in providing exceptional client service. Anna holds the Chartered Financial Analyst designation.
Bernadette joined CWB McLean & Partners' Client Portfolio Management team in September 2020. She is passionate about assimilating and explaining investment products, strategies and plans into comprehensible solutions for her clients, in order to provide greater reassurance and understanding.

You’ve heard us reiterate the mantra “stick to your long-term plan” dozens of times – it's good advice under any market conditions. But what precedes that advice is a thoughtful, meticulous assessment of your financial aspirations and abilities to create a plan that’s worth sticking to. This is known as investment suitability. 

Whether you’re a novice investor or have been investing for a while but, frankly, find the topic a bit dry and hard to follow (we know not everyone is obsessed with portfolio strategies, like us), there are some basic principles you should know. We’re here to share the primary practical and psychological considerations that underlie our process for determining your investment suitability, to ensure a tailor-made plan that suits you best.

What is investment suitability?

Bernadette - Suitability is a fundamental concept in portfolio management, comprised of two components. First, you must have a deep understanding of your personal financial circumstances. This involves assessing your age, financial situation and needs, investment objectives, time horizon, liquidity needs, tax status, investment knowledge and risk tolerance. The second component involves conducting thorough due diligence on the investments in question, to ensure they adequately meet your current circumstances and objectives. 

If both components are aligned, suitability has been achieved. However, your life circumstances are continuously evolving (e.g., getting married/divorced, having children/grandchildren, getting a salary increase or inheritance, losing a job, selling a business), so it’s important to reassess suitability as these changes occur.  

How does your level of financial literacy come into play when assessing investment suitability and risk tolerance?

Anna - It’s true that education and experience can influence your risk tolerance. For instance, someone who believes that equity markets are definitively not for them, based on their knowledge of a few fringe/speculative stocks, may change their mind after learning about dividend-focused or value investing. 

But once a base level of understanding is reached, risk tolerance is typically innate to a person’s character and no amount of facts, figures, or education from an advisor will change that – nor should that be their goal! At its core, the risk/reward trade-off that one settles on for their portfolio should make them feel just as good on the best day in the market as it does on the worst day. Lots of people would be happy with a +30% return – far fewer could stomach a -30% one.  

After all, being a stock-picking-wizard and reading the Wall Street Journal are not prerequisites for investing in the stock market. In fact, many people enjoy long-term investment success precisely by recognizing where their investment knowledge (or interest thereof) ends and where that of a trusted advisor begins. 

That said, it’s every investor’s duty to understand the level of risk involved in their investments. Some investors who view the Canadian banks as safe havens would be unsettled to learn that those very names were temporarily down 30% to 40% in March of 2020, for example. 

In that same vein, if you’re inheriting or being gifted family assets, you should never assume that just because an investment was suitable for your parents it will automatically be suitable for you. Having frank discussions with your advisor and erasing the discomfort around asking “obvious” questions (hint: there aren’t any) is crucial to building financial literacy to a point where you can confidently gauge your own penchant for risk.

What’s the difference between risk and market volatility?

Bernadette - Risk tolerance is an important factor when determining investment suitability, and there are two ways to gauge this: your willingness to take risk and your ability to. Risk willingness is largely intrinsic and measured by your propensity to take or avoid risk, whereas your ability to take risk depends on your financial health. 

Each type of investment carries a level of risk given its attributes. For example, a 1-year Government of Canada bond will carry far less risk than shares in a brand new, highly-speculative junior mining company. 

However, it’s important not to blur the notion of risk with gyrations of the capital markets that create volatility. There’s typically a relationship between the amount of volatility and level of risk, but this isn’t always the case. When serious unexpected events occur, such as wars or pandemics, uncertainty and fear can exaggerate typical trading and ultimately impact volatility.

How can excessively low-risk investments impact an investor’s portfolio? 

Anna - Excessively low risk investments (ones that are unlikely to produce the returns necessary to meet the holder’s financial objectives) can be just as detrimental to your success as excessively risky ones. 

For starters, investors should always remind themselves that no one is paying them out of the goodness of their heart. In other words, if you’re making a return of any kind – no matter how modest or guaranteed – then you are, in fact, being compensated for risk. 

Let’s take Guaranteed Investment Certificates (GICs), for example, which investors often refer to as “no risk” investments because of their principal protection guarantee. In fact, GICs are not “no risk” at all – they are simply “known risk.” Here, the GIC investor is offered principal protection and a more attractive return on their cash to compensate them for taking on liquidity risk (the risk that they may need their money before the GIC term is up and be unable to access it), interest rate risk (the risk that rates will rise while they’re locked in at the original, lower rate), and inflation risk (the risk that your return will not preserve their purchasing power). 

In the same way, when you opt for excessively low-risk investments – perhaps because you’re working with gifted or inherited monies which you feel you have a duty to preserve – you may believe that you’re avoiding risk altogether. In reality, you are just opting to take on the known risks of possibly not meeting your investment goals, outliving your money, or having your returns erased by inflation. 

Suitability is a marriage between your financial and personal circumstances to determine an investment strategy that's the right fit for you. Holding investments that don’t suit your needs or life situation can impact if, and when, you meet your financial objectives. So, take steps to improve your financial literacy and be proactive in revisiting your plan when significant life changes occur. This will empower you to feel more confident designing a plan that’s right for you.