Advice firms have generally treated formal assessment of clients’ tolerance of risk as an unwelcome necessity imposed by FCA rules, as evidenced by responses to a recent flurry of articles in Money Marketing. The trouble is the box-ticky ‘regulation-lite’ solutions many have adopted might be appropriate for simplified advice but are rarely up to the job where genuine financial planning is involved.
The FCA has made it clear that assessment of the client’s capacity for loss is the crucial element in the investment advice process. It is intuitively obvious that ‘How much can you afford to lose?’, or something like it, ought to be the starting point for professional investment advice. How someone feels about a loss is a secondary question, which most people will not be able to answer accurately until it happens.
For this reason, I have never been keen on attitude to risk questionnaires. The appearance of academic objectivity vanishes when you understand that for a psychometric questionnaire to be valid, it must be completed independently (no interaction with adviser or spouse) and must include only attitudinal questions.
One of the best ways of improving investment outcomes is to get people to talk freely about their aims and expectations. I am sure most professional advisers treat a risk questionnaire as a jumping-off point for what can often be deep and meaningful discussions.
A questionnaire that prompts such a discussion may meet the test of improving advice and investment outcomes. But it can still fail the iceberg test: the risk of challenges to investment suitability and recommendations several years after the advice was given.
At that point, documentation is critical and memo notes of a long-forgotten discussion are inadequate. The advice firm needs a systematic way of recording the reasons for allocating a risk profile to a client, the client’s understanding and acceptance of this and its link to the investments recommended.
I believe proprietors of adviser businesses need to adopt suitability assessment methods that give them both documentation of client assessments and management information about the behaviour of their advisers. ‘Playing back’ the answers to a questionnaire along with an interpretation can help clients to understand why a proposed solution meets their needs. Correctly used, the MI will enable adviser firms to head off any inappropriate advice and tailor their propositions to client needs.
The 20 questions in the Harbour questionnaire we use do not capture all the information that could cause an adviser to up- or downgrade a client’s capacity for risk. But capacity-related questions have a big weight in the scoring of the Harbour system and it also includes an ‘override’ that allows advisers to adjust the profile generated by the programme – with the reasons documented and added to the report issued to the client.
Risk profiling is not an exact science, but that is no reason to rely solely on the personal judgments of individual advisers. Intelligent risk profiling can improve outcomes and reduce risk for business owners.
Chris Gilchrist is director of Fiveways Financial Planning, a contributing author to Taxbriefs Advantage and edits The IRS Report