Interactive Investor

Investors get worse returns from poor adviser risk profiling

Experts say it is just as dangerous to take too little risk as too much.

11th January 2021 14:46

Marc Shoffman from interactive investor

Experts say it is just as dangerous to take too little risk as too much.

Investors may be getting poorer returns from advisers using badly designed risk-profiling tools.

Behavioural finance experts at Oxford Risk have warned that too many wealth managers view risk profiling as an unnecessary box-ticking exercise.

Risk-profiling tools help investors assess how much risk they are prepared to take with their money and the type of funds and strategies that may be most suitable for them.

But Oxford Risk says the profiling field is rife with misunderstanding and poorly designed assessment tools, with financial advisers often confusing tolerance of long-term risks with emotional responses.

Greg Davies, head of behavioural finance at Oxford Risk, says: “By conflating long-term risk tolerance with short-term emotional risk attitudes, advisers will potentially replicate all the silly things that investors do already, rather than helping to control investors’ more destructive tendencies.

“This is exacerbated by the ill-advised trend of using ‘revealed preferences’ and gimmicky ‘games’ to determine risk tolerance.

“Such over-engineered and unstable approaches to measuring risk tolerance are inappropriate and do not reflect clients’ actual willingness to take long-term risk.”

He says measuring the wrong thing is worse than not measuring at all.

Lisa Johnstone, director of financial planners VWM Wealth, says anything that helps educate the client around what to expect means that they are more likely to invest for the long term.

She adds: “Understanding and controlling behaviour mitigates anxiety and really helps the investment journey.

“I agree with the Oxford Risk comments that behavioural tools should not be a proxy for determining the suitability of a portfolio or the risk adopted.”

“This is completely separate and should be based not only on risk scoring and behaviours, which can determine the maximum risk an individual is prepared to take, but also their financial circumstances so in addition to the above how much risk should they take and what is their capacity for loss.”

Johnstone warns it is just as dangerous to take too little risk as it is to take too much.

 

​​​​​​​

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.