The way that high net worth (HNW) investors experience risk is changing, thanks to the financial crisis. Risk changed much of its meaning as the market swooped and dove over the last few months. The term “risk” can be defined as “the possibility of suffering harm or loss.”When speaking in the context of investments, risk can come in many different forms: liquidity risk, inflation risk, interest rate risk, and of course market risk (also referred to as systematic risk).

The events that have unfolded in the American financial system have been a blow to some; perhaps their first ever financial setback. Eighty-two percent of the affluent, before these tumultuous last few quarters, say they have never suffered a major financial setback in their lifetime. That answer may be different now. However, many investors that have had a financial setback aren’t afraid of taking risks going forward. A higher percentage of those that have had setbacks classify themselves as “aggressive” versus those that haven’t. Coupling this with the finding that those that have faced setbacks are significantly more concerned about adequate retirement funding, it may be necessary for this group of investors to take additional calculated risks in order to reach financial goals.

Another big question is how will the use of leverage change now for the HNW? Respondents for a Spectrem survey were asked: “Other than purchasing a home, have you ever borrowed money to make what you would consider an investment?” Leverage can come in many different forms, from credit cards to margin accounts, but the root of the concept is investing money with borrowed money. While the use of leverage can potentially help an investor create wealth more rapidly, it can also magnify losses. Thus, it can be argued that higher degrees of leverage carry higher degrees of risk.

One-third (33%) of the HNW investors surveyed have employed some form of leverage for the purpose of making an investment. Business Owners are by far the most frequent users of leverage. Sixty percent (60%) stated that they have used leverage in the past. From a gender standpoint, 42% of men utilized leverage compared to 23% of women. The use of leverage is not necessarily reserved for the youngest investors. Investors that are 50-64 utilize leverage just as much as those under age 50. In light of this, leverage should be discussed as a potential tool for financial planning with younger and older clients alike.

Leverage and risk are concepts that could be redefined in the new financial situation created this year and Business Owners are nervous about the future. One small business owner says, “Although the economy wasn’t feeling so good to us, at least we knew what to expect and how to protect ourselves against it.” Now Business Owners and affluent investors alike aren’t sure what the market is or what the future holds. Discussing your client’s risk tolerance on an ongoing basis during this financial crisis and beyond is critical.

For additional information: Manage Your Client Relationships through the Financial Crisis: Be Pro-Active, Not Reactive

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