Constantly updated risk profiling questionnaires help in determining the proper advice the clients need
There has been a lot written in the media recently about the challenges facing those approaching retirement. More quantitative easing and falling annuity rates the latest to be discussed.
However these are by no means the only risks that people in, or nearing, retirement are currently exposed to. Good retirement planning will consider an individual’s attitude to risk and develop strategies to control risks in line with the stated aims of the individual.
A good strategy will sift through these risks and categorise them into those that can be managed to some extent and those that cannot. For example, political, legislative, longevity and mortality risks could be difficult to anticipate, but counterparty risk can perhaps be assessed by due diligence and minimised by investor protection schemes.
The risks that are, in theory, easier to address are investment and asset allocation risks. This is where the FSA’s pronouncements on investment suitability and risk profiling feature in the equation.
The FSA has said that adviser firms should have a process for understanding their clients’ attitude to risk. Clients should be asked to think about what their attitude to risk is, not necessarily in relation to their finances specifically, but conceptually. They should spend some time thinking about the concept of taking a risk, how it makes them feel and particularly weigh this up against the sorts of returns they require from investing. Attitude to risk should also be something that is reviewed regularly to take into account changes in circumstances.
Another key theme is that firms must also consider carefully the customer’s overall financial situation and whether they have the capacity to absorb losses that could arise from investing in accordance with their stated attitude to risk. If there is a discrepancy between the two, it is up to the firm to explore this with the customer and if necessary alter the customer’s risk assessment accordingly and this needs to be a more in-depth and holistic process for many firms.
The use of risk profiling tools warrants a more detailed look because such tools are increasingly used by firms and the FSA has some significant concerns in this area.
Something that makes the job of a financial planner interesting is that every client is different. It is these differences that make it impossible to establish the level of risk that every client is willing to accept for the rest of their lives based solely on the output from one set of questions.
Risk can never be an exact science and any risk profiling questionnaire or other system can only ever be viewed as a guide to bring a degree of consistency to the process. A questionnaire can act as a “proof point” for advisers to be used in future reviews in reaction to changing circumstances, but a detailed discussion of risk with the customer is needed to ensure clarity. It has been suggested that many firms assess attitude to risk and discuss this with their clients, but fail to discuss their conclusions in detail with them. These valuable conversations are in danger of disappearing as a result of the proliferation of risk-profiling tools.