2.2 Risks Facing the Investor & the Client's Needs
Key Takeaways
The curriculum lists seven investment risks: inflation, interest rate, market, liquidity, foreign exchange, credit and industry risk.
Client-specific risks include low financial literacy, job loss, outliving one's money (longevity), bankruptcy or lawsuits, and liquidity problems.
Each risk points to a need: income, retirement income, estate planning, an emergency fund, creditor proofing, lump-sum savings, capital preservation, growth, inflation protection, diversification and professional management.
Segregated fund guarantees address market risk near death or maturity; life annuities address longevity risk; family-class beneficiary designations address creditor risk.
Inflation erodes purchasing power: at 3% a year, $1 of spending today needs about $1.34 in 10 years.
Risks Facing the Investor and the Client's Needs
A recommendation only makes sense when the agent can name the risk the client faces and the need it creates. Sub-component 1.3 lists both.
1. Investment Risks
| Risk | What it means | Example | Product response |
|---|---|---|---|
| Inflation risk | Rising prices reduce what money can buy | A $40,000 level annuity buys less every year | Equity or balanced funds for growth; indexed annuities; keep part of the portfolio invested |
| Interest rate risk | Bond prices fall when rates rise; reinvestment rates may fall | A bond fund drops 7% when rates rise 1% (duration of 7); an annuity bought when rates are low pays less for life | Shorter-term bond funds; laddering annuity purchases over time |
| Market risk | The whole market falls, so diversification cannot remove it | A balanced fund loses 15% in a recession | Segregated fund maturity and death guarantees; time horizon |
| Liquidity risk | An asset cannot be sold quickly at a fair price | A real estate fund restricts redemptions; a life annuity cannot be cashed in | Emergency fund outside the product; money market funds |
| Foreign exchange risk | Currency moves change the value of foreign holdings in Canadian dollars | A US equity fund falls in Canadian-dollar terms when the dollar strengthens | Currency-hedged or Canadian funds; diversification |
| Credit risk | A borrower defaults or is downgraded | Corporate bond prices fall after a downgrade | Government bond funds; diversification; Assuris for insurer failure |
| Industry (sector) risk | Problems in one industry hurt all companies in it | An energy fund drops with oil prices | Broad diversified or balanced funds rather than specialty funds |
The economy as a whole sits above these: recessions, rising unemployment and central bank rate changes move every asset class (see section 2.1).
2. Client-Specific Financial Risks
| Client risk | What the agent looks for | Typical response |
|---|---|---|
| Low level of financial literacy | Difficulty understanding volatility, fees or guarantees | Simple products, clear explanations, written summaries; guarantees can prevent panic selling |
| Risk of job loss | Unstable industry, contract work, single income | Larger emergency fund; avoid locking money up; disability and life insurance |
| Risk of outliving money (longevity) | Good health, long-lived parents, no defined benefit pension | Life annuity or lifetime withdrawal benefit (GLWB) for part of the savings |
| Risk of bankruptcy | Business owner, professional with liability exposure, guarantor of business debts | Segregated funds or annuities with a family-class or irrevocable beneficiary, set up while solvent |
| Liquidity issues | Most wealth tied up in a home, business or locked-in plan | Build accessible savings before long-term commitments |
3. The Client's Needs
The curriculum's list of needs is the vocabulary of exam answers:
- Need for income for the individual, the spouse or the couple, now or after a death.
- Need for retirement income for the individual, spouse or couple: how much, starting when, for how long.
- Need for estate planning: passing assets to heirs quickly, privately and with lower probate costs.
- Need for an emergency fund: typically three to six months of expenses in liquid savings.
- Need for creditor proofing: protecting savings from future business or professional claims.
- Need for lump-sum savings: a goal such as a home, education or a large purchase.
- Return on investment: capital preservation, growth, or inflation protection (keeping real value).
- Diversification: spreading risk across asset classes, regions and managers.
- Investment management: professional management for clients who lack time or skill.
4. Matching Needs to Product Features
| Need | Segregated fund feature | Annuity feature |
|---|---|---|
| Capital preservation | 75% to 100% maturity and death guarantees | Guaranteed payments |
| Retirement income | Systematic withdrawals; guaranteed withdrawal benefits | Life or term-certain income |
| Longevity protection | Lifetime withdrawal benefit (GLWB) | Life annuity with mortality credits |
| Estate planning | Named beneficiary outside the estate; death benefit guarantee | Guarantee period or refund feature paid to a beneficiary |
| Creditor proofing | Family-class or irrevocable beneficiary | Same rules apply to annuity contracts |
| Growth and inflation protection | Equity and balanced funds; resets | Indexed annuities (lower starting income) |
| Liquidity | Withdrawals allowed (guarantees reduced) | Little or none once payments start |
5. Putting a Number on Inflation
Retirement needs must be expressed in future dollars. The future value formula from the curriculum's sample questions:
At 3% inflation, today's $1 of spending needs , about $1.34, in 10 years and , about $1.81, in 20 years. A couple who need $60,000 a year in today's dollars and retire in 10 years should plan for about $80,600 in their first year of retirement ().
Real return is the return after inflation:
A GIC paying 3.5% when inflation is 3% earns a real return of only about 0.5%, before tax.
6. Case: Naming the Risk Before the Product
Sanjay, 47, is a self-employed engineer with a single income, a mortgage, two teenagers and $180,000 in non-registered savings. He fears a professional liability claim and a stock market crash before his children's university years.
- Risks: bankruptcy or lawsuit risk (business), job-loss risk (single, self-employed income), market risk, and liquidity risk (education costs in 3 to 6 years).
- Needs: creditor proofing, an emergency fund, lump-sum savings for education, and long-term growth.
- Direction: keep an emergency fund and the education money in liquid, low-risk holdings (or an RESP); place long-term savings in a segregated fund contract naming his spouse or children as beneficiaries while he is solvent and no claim exists, accepting higher fees for the creditor protection and death benefit guarantee. A maturity guarantee alone would not help with costs due in three to six years, because it applies only after at least 10 years.
A retired client holds most of her savings in a US equity segregated fund. The fund's holdings rise 4% in US dollars over the year, but the client's statement shows a loss in Canadian dollars. Which risk caused the loss?
Credit risk, because the companies in the fund defaulted on their bonds
Foreign exchange risk, because the US dollar fell against the Canadian dollar
Liquidity risk, because the fund could not sell its holdings quickly
Industry risk, because all the companies held in the fund belong to one single sector
Which client need is most directly met by naming a family-class beneficiary on a segregated fund contract while the client is solvent?
The need for inflation protection
The need for creditor proofing
The need for an emergency fund
The need for diversification
A couple need $50,000 a year in today's dollars and plan to retire in 8 years. Using 3% annual inflation, about how much will they need in their first year of retirement?
$50,000, because retirement income needs are measured in today's dollars
$51,500, because inflation is applied only once
$63,300, which is $50,000 grown at 3% a year for 8 years
$62,000, which adds 3% simple interest for 8 years
Sections you finish are checked off in the contents.