Assessing someone’s appropriate risk level is hard.
The financial services regulator, the FCA, recommends best practice of testing ‘attitude’ to risk, capacity for loss and knowledge/experience.
Attitude is the easiest to test as this can be done through a series of questions asking the individual how they would respond to different circumstances (a fall in the value of their investments or a choice of different portfolios with different potential gain/loss profiles). As well as being the easiest to test it is also the most open to debate as to its usefulness. People are not robots and will answer these questions differently depending on their current context and recent experience. How you ask should be the most important factor in outcomes but often it is when you ask.
Capacity for loss is more scientific as it can only be done properly by mathematically assessing how well someone’s wealth will cope with large drawdowns. This is not well measured in general and sometimes is turned into a questionnaire asking how well people think they will cope (which is back to attitude and is not a proper test of capacity).
Knowledge and experience are easy to assess through a quick question set about what the person has done about investments in the past and how well they understood them.
We use the excellent risk assessment provided by Timeline with all MyChoice opt-ins, which assesses all these three points as they should be assessed, combining cashflow with questionnaires to assess capacity.
I wonder though whether even the best risk assessment tool needs to be upgraded for the 21st century.
There are multiple personality tests on the market and the type of person you are, can have as much if not more impact on investment suitability than attitude to risk. In particular, they are useful in understanding how individuals are likely to react to external prompts and pressures. Even the FCA itself is getting into this game through their newHype Type Analyser tool. It is deliberately coded to help people self-assess how they react to investment signals from fast moving social media.
Even better would be a question set built into these tools which asks people to describe their earliest money memories. The research in this area shows that we pick up a lot of our attitudes to money before the age of ten, and are therefore deeply embedded in our unconscious.
There is no point in gathering further data about investors though, unless there are solutions tailored to the answers we get. The data we gather would be vast, but AI can help with this as it is bad at many things but good with big data sets. However, what do we advise a person who has a low risk outcome, a go getter personality type, lost a family member to lung cancer and traumatic memories of parental rows around money. What is the advice/investment solution for someone like this?
Perhaps the answer is two-fold.
Firstly, matching a bespoke investment solution to the risk profile of the client and the exclusions that they care about. Then finding a communication style that suits their personality type. Maybe a low equity portfolio with a tobacco and Phoenix exclusion would suit this individual. Matched with an advice relationship that was caring and inclusive of their spouse. They could then receive regular updates about the success stories of some of the company shares they were investing in.
We don’t know how this area will evolve but as it does, we will be close to the front of the pack by delivering it to Phoenix staff throughout the UK.
