How advisers can ask the right questions to best ascertain a client’s risk tolerance.
Whatever role you have it makes commercial sense, even if there is no specific legal requirement, to undertake a rigorous due diligence of the processes and tools used in formulating advice.
Failure to do so leaves the business open to claims of negligence and incompetence. In the case of risk profiling, poor processes add professional and reputation damage.
Further, there is a high risk of clients being given advice that doesn’t meet their needs. Unhappy clients, with unsuitable investments, have in many jurisdictions around the world access to formal complaints processes, such as Financial Ombudsman Services as well as the courts.
Over the years I have been asked how best advisers might carry out a due diligence process for risk profiling questionnaires.
So a couple of years ago we engaged Stuart Erskine MA, a leading UK financial services consultant and economist, to develop a due diligence framework advisers, planners, providers and robo-advisers/developers could use to ensure the risk test(s) they use are robust and trustworthy.
We also enlisted specialists in the field of psychometrics, Professor Irinini Moustaki and Dr. Myrsini Kasitkatsou, from the London School of Economics to review the integrity of the due diligence process.
Here are a series of checklists, which advisers should put in place on their questionnaires, on everything from risk profiling, testing, scrutiny and the assumptions underpinning the questionnaires.
Risk profiling due diligence check list
This was created by Stuart Erskine, MA, financial services specialist and economist, and reviewed by Irini Moustaki, professor in social statistics at the London School of Economics, and Dr. Myrsini Kasitkatsou, PhD, also at the London School of Economics.
1) Face validity
On reading the questions in the questionnaire:
a. Do they make sense to you? Can you understand them? If not then there may be an issue; clients may struggle to interpret the questions, the report will likely be inaccurate and the final advice possibly flawed.
b. Does the content and wording of the questionnaire appear valid in as much as the questions actually relate to financial risk tolerance? The questions should be related to the topic of financial risk, if not then the test may not be valid.
c. Are there a variety of questions? Do they differ from each other? Is there any repetition? You need to see variety, not the same or similar question asked multiple times, otherwise the questionnaire will not be valid.
2) Design provenance
a. Has the questionnaire been designed by relevant field experts/academics (i.e. with financial sector and statistical experience)? It is a concern if the questionnaire does not have relevant expert origins.
b. Can those academics be referenced and verified? Check their existence and relevance of their academic achievements.