Conversely, we sometimes see new clients mask their uncertainty by manufacturing a higher level of financial sophistication than they really have, which can lead to them not getting the advice they need.
These are, of course, just a handful of the factors prompting nervousness in new clients. To cater to a nervous investor, the adviser needs a comprehensive risk-profiling process that delves into the individual experience and goals of the client, and establishes how much risk they are actually willing to take.
Undertaking a comprehensive risk-profiling assessment
Risk profiling is arguably one of the most important parts of the investment process. From a regulatory perspective, Financial Conduct Authority rules state that businesses are obliged to develop an understanding of their clients’ investment objectives and risk tolerance to provide them with the most suitable recommendations.
A reliable risk-tolerance test is not only an essential investment planning tool but also an important data point that – when used as part of in-depth discussions about risk – can help an adviser better understand a client’s values, beliefs and behaviours, while at the same time immersing the client in the investment process.
The concept of risk is undeniably complex, and there are numerous factors that every adviser must consider. First, what level of tolerance, capacity, knowledge and experience does the client have to ensure an appropriate amount of risk is taken?
Second, does the potential return of the investment fairly compensate the client for the risk taken? What may be a good investment – with risk fairly compensated by potential return – may be an inappropriate level of risk for the individual because of who they are.
In my view, risk-profiling should be a multi-step process that starts with a psychometric questionnaire followed by general conversations that review these answers in more depth.
When conducting a risk-profiling assessment, the following areas should be explored:
1. Attitude to risk.
When meeting a new client, the adviser must objectively measure their attitude to risk concerning their investments, considering their thoughts, emotions, and behaviours towards taking financial risk.
A new investor may show signs of hesitancy when starting to invest in the stock market compared to someone who has been through previous market cycles – but that does not necessarily mean that a very low-risk strategy is the right solution to help that client achieve their needs.
An adviser’s role is to help the client think beyond their initial nerves and consider their attitude to risk-taking more broadly.
2. Capacity for loss.
In addition to understanding client’s willingness to take financial risk, it is also important to discover how much they can afford to lose before this has a detrimental effect on their lifestyle and standard of living.
