White Papers :: Psychometric Risk Tolerance Assessment

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Newsletter Articles and White Papers

2012

Risk Profiling: Art and Science
Investment suitability is the foundation upon which good investment advice is built. Not only must the investment be suitable with regards to the investor's goals (risk required) but also with regard to her risk capacity and risk tolerance. Risk Profiling is the term commonly used to describe how advisers ensure Ensuring that investment recommendations are suitable with regard to these three aspects of risk. This paper explores the development of risk profiling, clarifies terminology, considers regulatory requirements, examines the processes and tools required, and highlights common adviser mistakes. Risk Profiling is a blend of art and science. The science lies in the tools the adviser uses. The art lies in the adviser's ability to use the tools effectively ...

Risk Profiling: Art and Science (AUS Version)
Risk Profiling: Art and Science (NZ Version)
Risk Profiling: Art and Science (US Version)
Risk Profiling: Art and Science (CAN Version)
Risk Profiling: Art and Science (UK Version)
Risk Profiling: Art and Science (ZA Version)

The Same Approach to Risk Will Mean Less Confused Clients
FinaMetrica co-founder and director discusses the 'five proofs' which are a simple easily administered test that enables advisers to quickly assess the completeness of their advice.

On the Stability of Risk Tolerance
It is widely believed that (financial) risk tolerance is highly unstable and particularly subject to market conditions. However, through a series of independent studies there is now strong evidence that this view is incorrect. The most recent study clearly demonstrates the stability of risk tolerance across the 2003 to 2009 market rises and falls through detailed analysis of test/retest data, involving two tests of the same individuals, the first during the 2003-7 bull market and the second in the subsequent bear market. The study confirms the anecdotal evidence from FinaMetrica subscribers that clients' risk tolerance scores remained remarkably stable through the most turbulent market conditions in living memory.

2011

FinaMetrica's Response to the Financial Services Authority's Guidance Consultation on Investment Advising
FinaMetrica welcomes the FSA's guidance paper. To our knowledge it is the first serious attempt by any regulator to address the issues of an investor's willingness and ability to take risk. The paper makes a significant contribution to improving the quality of advice which is a starting point for the journey to a more secure investment world. Perhaps the most satisfactory aspect from FinaMetrica's perspective is that the FSA has identified the fundamental weaknesses in 9 of 11 industry-standard 'portfolio-picker' risk questionnaires.
FSA's guidance paper
FinaMetrica's note to subscribers
FinaMetrica's response to the FSA paper
Feedback from FinaMetrica users who have been audited by the FSA

Ten Emerging Trends in the UK's Financial Services Market
FinaMetrica cofounder, Paul Resnik, is just back from a seven week trip to the United Kingdom. Paul spoke with several hundred industry participants in 12 cities. Almost all product and service suppliers are currently engaged in reframing their business proposition to take account of the impending regulatory changes or building to take advantage of the opportunities created by the failure of competitors. High-end IFAs in particular are significantly more optimistic about the future than most others. Many are further advanced on the journey to acceptable practice and some moving towards best practice. Most felt that the banks and life companies were at a disadvantage in terms of both momentum and public trust.

Five Myths of Risk Tolerance and How To Understand Them Better
Discussions about risk tolerance often include more fiction than fact. Cobus du Plessis from the Institute of Behavioural Finance, our South African business partner, succinctly exposes the five most common myths about risk tolerance.

AICPA Planner Magazine This five-part series written for the American Institute of CPAs' Planner magazine provides a comprehensive treatment of the issues surrounding clients' risk tolerance in bite-sized chunks.

Part 1: Managing The Risky Business of Advice FinaMetrica's view is that an investment strategy should be driven by goals, risk capacity and risk tolerance, in that order. Goals are the primary driver; risk capacity acts as an upside constraint on investment risk; risk tolerance provides an emotional target for investment risk. Emotionally there can be both too much risk and too little risk in an investment strategy. Usually, given investors' optimism about what are achievable goals, the adviser is dealing with a too-much-risk scenario. This article explores the interplay between goals, risk capacity and risk tolerance in more depth. You may be surprised at how risk capacity is characterised and how it fits into the planning process.

Part 2: Using Psychometrics to Access Risk Tolerance An introduction to psychometrics as the scientific solution to assessing your clients' risk tolerance.

Part 3: Avoid Industry-Standard Risk Questionnaires Industry-standard risk questionnaires have been shown through numerous studies to be highly unreliable and a likely cause of the inaccuracies in advisers' understanding of their clients' risk tolerance.

Part 4: Linking Risk Tolerance Risk to Portfolio Risk A client's risk tolerance affects all financial decision-making but is usually most critical in the decision regarding a long-term investment strategy. It is easy to say that a client's investment strategy should be consistent with their risk tolerance but how does one compare risk tolerance to portfolio risk?

Part 5: Increasing Cross Referrals and Profits by Reducing Portfolio Surprises Clients will become unhappy if they discover in a falling market that they were exposed to what, for them, is too much risk. Clients will also be unhappy if they discover that they didn't understand the risks they were taking. It's up you to help them; but, along the way, there should be no surprises. Here's how to ensure that happens.

Archive

Advising in a Volatile Market Series This series is a key example of applied behavioural finance, enabling best practice in financial risk tolerance understanding, assessment, management and education. The papers are practical and focus on immediately applicable practice tips.

Part 1: Why your clients are feeling the way they do and what you can do about it. FinaMetrica has been helping advisers better understand the challenges of advising in a volatile market with our 'Advising in a Volatile Market' series. The papers are practical and focus on immediately applicable practice tips. This series is a key example of applied behavioural finance, enabling best practice in financial risk tolerance understanding, assessment, management and education.

Part 2: How to manage your client's expectations (AUS Version) Part 2: How to manage your client's expectations (UK Version) Part 2: How to manage your client's expectations (US Version) FinaMetrica has been helping advisers better understand the challenges of advising in a volatile market with our 'Advising in a Volatile Market' series. The papers are practical and focus on immediately applicable practice tips. This series is a key example of applied behavioural finance, enabling best practice in financial risk tolerance understanding, assessment, management and education.

Part 3: How misinformation and misunderstanding lead to unrealistic expectations ... (AUS Version) Part 3: How misinformation and misunderstanding lead to unrealistic expectations ... (UK Version) Part 3: How misinformation and misunderstanding lead to unrealistic expectations ... (US Version) FinaMetrica has been helping advisers better understand the challenges of advising in a volatile market with our 'Advising in a Volatile Market' series. The papers are practical and focus on immediately applicable practice tips. This series is a key example of applied behavioural finance, enabling best practice in financial risk tolerance understanding, assessment, management and education.

Risky Business
Untangling the four primary aspects of risk – risk required, risk perceived, risk capacity and risk tolerance - will help you give better advice, build stronger relationships with clients and secure your practice. These four aspects are sometimes confused in advisers' minds, which leads to client confusion. In these challenging times, risk has become a key issue for clients. As investment markets have fallen, it is likely that risk required has increased and risk capacity has decreased; this presents an opportunity for advisers to add value by giving clients a clear framework to understand the full risk picture. With new clients, this can be done from the start of the relationship; with existing clients, the relationship can be enhanced by having a better informed risk conversation at the next review.

Risk Tolerance Revisited – Some Surprises
We hear much talk of clients' risk tolerance collapsing in the current crisis ... but the research evidence disagrees. We know that behaviour has changed and many mistakenly believe that this is due to changes in risk tolerance. However, other factors appear to be the more likely causes. Advisers can benefit by having a more insightful understanding of what is happening with their clients in these difficult times.

Global Financial Crisis Survey
From December 2008 to July 2009, FinaMetrica surveyed advisers and their clients regarding the impact of the Global Financial Crisis (GFC).
Analysis of the data confirms some accepted wisdoms but also reveals surprises, three of which are:
- Clients appear to have an unrealistic expectation that their adviser can protect them from the vagaries of the market,
- Advisers seem to have been too surprised by the market falls, given the market's relatively recent history.
- Incontrovertible evidence of the stability of risk tolerance which, though not a surprise to us, does disprove accepted wisdom.

Applying Behavioural Finance Today ... for Your Clients’ and Your Benefit
How to plan when the sky is falling? One of the most useful approaches we know of arose at a recent technology conference in Dallas. And yes, while the tool employed was planning software, the substance was behavioural finance.

Financial Planning at the Crossroads?
The Storm crisis is revealing a number of fundamental flaws in the Australian financial services landscape. All of them impact upon the reputation of professional financial planners. There was no risk tolerance undertaken, the accounting for fees was possibly wrong, the relationship with lending institutions was questionable and the FPAs response probably inappropriate. Our clients almost invariably run their own practices and anything that damages planner's reputation hurts the FinaMetrica business. FinaMetrica co-founder Paul Resnik makes some suggestions as to what needs to be done.

Risk Tolerance, Risk Profiling and the Financial Planning Process
Advisers generally accept their professional, ethical and legal obligation to form a view of their clients' risk tolerance and to take that view into account when giving advice. However there is no general agreement as to what risk tolerance is, how it should be assessed and how that assessment should be applied in the planning process. What we know about risk tolerance has been compiled here to address these issues.

In Defence of Financial Planners and Financial Planning
The true test of financial planning success is client and fund retention. Planners do it well… Industry funds don’t. Now is not the time to be weakening confidence in the benefits of financial planners. The financial world has turned into a dark and unpredictable space where no one knows, at least in the short term, what will happen next. Now more than ever there is a need for every investor to have access to some one knowledgeable and caring to talk with about their financial issues.

Re-engage your clients with a proactive and personalised service that lets them own their plan
The financial world is in turmoil. Most clients are confused and anxious about how it will affect them. By bringing together behavioural finance, our own research and the practical insights from one of our long term users, we have some practical suggestions on how you can be proactive, review client portfolios, better match those portfolios to clients' needs and, in the process, help clients take responsibility and ownership of their financial plan.

A Challenge to All Financial Planners
"Am I the client or is it my money?" by FinaMetrica co-founder and Baby Boomer Paul Resnik. For those struggling in the current investment performance reporting season this paper outlines a way forward for financial planners dealing with the demands of Boomer clients.

Knowing your clients’ risk tolerance is key to a meaningful and rewarding ongoing relationship
"The service of personal financial planning is provided by a personal financial planner to assist clients with their personal financial planning (ISO 22222 – Personal Financial Planning). Personal financial planning is a process designed to enable consumers to achieve their personal financial goals." By starting from this definition, which asserts a consumer focus, it is possible to deal more effectively with many financial planning issues particularly accountability and ongoing adviser remuneration.

Using World's Best Practice in Your Clients' Financial Risk Tolerance Assessments
A short article on financial risk tolerance assessments and why FinaMetrica is receiving industry accolades.

Assessing Risk Tolerance: A Micro-Behavioural Finance Case Study
This chapter from The Investment Think Tank, Bloomberg Press, 2004, written by FinaMetrica's Co-founder and CEO, Geoff Davey examines what is known and understood, from academic and other research, about risk tolerance, how to assess it and how to apply that assessment in the planning process. It demonstrates how a scientific approach to managing behavioural finance issues at the individual level leads to better understanding of the issues and better outcomes for adviser and client.

Risk Tolerance Assessment in the Current Legal Environment
This September 2004 paper represents the most recent analysis of the legal requirements surrounding risk tolerance assessment.

Best Practice Process Standards
This paper results from an invitation to the author to present to the Institute of Financial Planners of Hong Kong at their Forum on 12 February 2003.

The Shadow Shopper Trial: Good News for Good Planners
Forget the doom and gloom of the shadow shopper trial. For good planners, this is one cloud with a silver lining. Focussing primarily on client dealings, here's what you can do today as a financial planner with: your clients, your dealer, your fund manager, your association and Standards Australia.

Scientific Risk Profiling
FinaMetrica's submission to the risk profiling study conducted by the Professional Standards Committee of the Australian Financial Planning Association.

Investors Behaving Foolishly
A commentary on the implications for investors, investment clubs and financial advisers of studies conducted by Professor Terrance Odean.

Financial Risk Tolerance: A State or Trait?
Master of Applied Psychology thesis, Ulla Yip, University of New South Wales.