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Case Study: The need to get risk assessment right


Question: When reviewing our advice process to ensure it is in line with the RDR, we are considering the way we assess clients’ attitude to risk. Why is this important?

The solution: Flicking through a newspaper the other week, I noticed an advert on the back page.

It read: “Have you suffered losses because you were mis-sold an investment by your bank, building society or financial adviser?”

It then went on to list circumstances in which a claim could be possible:

  • You were sold an investment without having been properly advised of the risk

  • Your personal circumstances or attitude to risk were not properly considered

  • You were sold a SIPP or poorly performing annuity

  • You were advised to invest all or most of your savings into a single investment

  • You were advised to unnecessarily transfer a pension

  • You were sold a property investment

  • Your pension is worth little more or less than the contributions you have paid into it

  • You were sold a guaranteed investment plan/bond and, although you received your money back, you have lost years of interest

Some of the circumstances are worded so widely as to make little sense while a few are real fishing expeditions.

The interesting point for me is that, in most of these cases, the actual transaction is probably not in itself wrong, but it can lead to a variety of different outcomes depending on many other influences.

Even then an outcome, either positive or negative, may not be absolute, and can change over time or with the buyer’s attitude to risk.

The very nature of a long-term investment product means there is rarely an absolute success level, but there is soon a failure level. In behavioural finance, prospect theory suggests that we value losses and gains differently and our tolerance for losses is actually lower than our appreciation of gains.

This has become even more important with some of the volatile markets that we have seen in the last few years. Investors may only be part way to their goal but may currently be sitting at a lower value than anticipated – perhaps even lower than the starting point.

Changing client circumstances might also make people think twice about a long-term financial commitment, particularly when there is the option of immediate cash back for no cost.

This fits in very neatly with the 2011 FSA paper “Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection”and subsequent Dear CEO letters.

Since this work there has been a whole industry generated around risk profiling and assessing a client’s attitude to risk (for me, the key phrase in the paper’s title was “willing and able to take”). There has also been a further call for a focus on capacity for loss.

The most important thing though is the need for comprehensive record keeping and documentation.

It is essential to know your client, to document investment risk, capacity for loss and the reasons decisions were taken, and to evidence it all with a date and the client’s signature. Hindsight can be 20/20 vision, so be prepared to have the evidence to avoid this.

I guess our industry does involve a lot of intangibles over a long period of time. Obviously, it also involves money. This leaves it open for such claims, so we must, like the FSA, always focus on risk and suitability for the end consumer.

Mike Morrison is head of platform marketing at AJ Bell


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