Financial advisers need to engage in less systematic risk tolerance testing to position clients for high investment returns, according to risk profiling firm Oxford Risk.
Speaking at a FinaMetrica/miPlanPlus event today, Oxford Risk head of behavioural finance Greg Davies says suitability across the industry is “rife with poor practice”.
Davies says the most common adviser mistakes are testing clients’ numerical knowledge and probabilistic reasoning, and referencing current market conditions.
Confusing risk tolerance with other risk attitudes such as behavior and investment objectives may also see clients tolerance plans missing the mark.
Davies says: “People look to behaviourally make themselves comfortable. It’s never enough to provide the right portfolio, that is only the first step of the outcome and you cannot get increasing returns without risk.”
Despite advisers’ focus on risk management, Davies says little focus has gone into properly managing risk capacity and its balance against investors’ expected returns.
He says: “No one quite understands what it means and there are no good tools out there; typically, the industry, regulators and tool providers have just focused on risk tolerance because that is the easy piece of the puzzle.”
He adds: “Determining suitability risk is a mixture of risk tolerance, risk capacity and required risk because it’s never enough to provide the right portfolio, that is only the first step of the outcome. People only get good investment outcomes if they stick with a good solution.”
Davies says many advisers’ current tolerance tests, which ask clients to answer A versus B questions, result in planning around short-term mentalities.