While it is obviously important to establish a client’s attitude to risk, what is just as important is to work out why they have that attitude in the first place. How did their relationship with money develop?
This was reinforced recently in a meeting with a new client very open on the topic. They explained they had an “unhealthy attitude” to money, inherited from their parents who were Holocaust survivors.
The client grew up knowing money was a big, important, powerful thing (to their parents, having it or not meant the difference between life and death) yet it was never talked about. As a result, they grew up being fearful of money and have always avoided dealing with it, keeping everything in cash.
The meeting led me to revisit the FCA’s guidance on risk and has made me think it needs updating.
Its webpage on assessing suitability was last updated on 18 May 2017. When you click on the link for “guidance on risk” it takes you to the FSA’s – yes, the FSA’s – finalised guidance on Assessing Suitability: establishing the risk a customer is willing and able to take and making a suitable investment selection – March 2011.
And while it looks at best practice, the document is missing something pretty vital: the behavioural element.
Behavioural economics has come to the fore in recent years, with the Nobel Prize for Economics won by Daniel Kahneman in 2002 and Richard H Thaler in 2017 for their contributions to this field of study.
Many of us are moving on from tools encompassing the psychometric risk profiling approach mentioned in the finalised guidance. The latest tools incorporate behavioural finance to provide us with an in-depth analysis of our client’s investor personality. Some even say they can provide tailored recommendations taking into account cognitive biases and preferences.
Advisers are picking up on the importance of behavioural finance and working it into their processes – not just at the assessing suitability stage but as part of their ongoing relationship with clients.
We need to take into account the fact clients make financial decisions that might not seem to be the best in our eyes, and do not follow given economic theories. We need to understand how and why it happens and what we can do to help them improve their relationship with money. This should lead to better financial decisions, which will help them achieve their goals.
The FCA’s guidance should reflect these changes to the advice landscape.
As for my client? They are determined to change their relationship with money and I look forward to having the honour of working with them on that journey.
Claire Phillips is partner at First Wealth