Glossary · UK
What is Capacity for Loss?
A client's objective financial ability to absorb investment losses without it materially affecting their standard of living or ability to meet financial commitments.
Full Definition
Capacity for loss is an assessment of a client's objective financial ability to withstand investment losses -- including, in a worst case, losing some or all of the money invested -- without it materially damaging their standard of living or their ability to meet essential financial commitments, and is a distinct concept from attitude to risk, which instead measures how comfortable someone feels, emotionally and psychologically, with the possibility of losses. A regulated financial adviser is required to assess both factors separately before recommending an investment: a client might have a high tolerance for risk emotionally (attitude to risk) but a low capacity for loss in practice, for example an older client relying entirely on a modest pension pot for essential retirement income, where even a temporary fall in value could force them to sell investments at a loss to cover living costs, making a low-risk approach more suitable regardless of how comfortable they personally feel with market ups and downs. Conversely, someone with substantial other assets, secure income, or a long time horizon before they need to draw on the money being invested typically has a higher capacity for loss, since a temporary fall in value is less likely to force them into a costly decision at the wrong time, even if their personal appetite for risk (attitude to risk) is more cautious. Because capacity for loss is meant to be an objective, evidence-based assessment of a client's actual financial position -- rather than a feeling -- advisers typically base it on factors established during the fact find, such as other savings and assets held, essential versus discretionary income needs, how soon the money might be needed, and whether a loss could be recovered from other sources, and where the two measures point in different directions, good practice generally treats the lower of the two (capacity for loss or attitude to risk) as the effective limit on how much investment risk is genuinely appropriate.