Current risk profiling fails clients
Current questionnaire based risk profiling is failing clients and advisers and is unable to provide defensible reasons for advice decisions according to a US based financial services strategy group.
Capital Position chief executive Bernard Del Rey said the current crop of ‘stated preference’ questionnaire based risk profiling assumes clients can accurately state their preferences in complex areas such as risk tolerance and loss aversion but they often did not understand these concepts.
He also claimed that questionnaire based surveys provided no “statistical confidence” in its classification of clients in that they lacked “mathematical or scientific proof through which the survey methods can be verified”.
“Many risk profiling systems that we have seen have been built as bespoke offerings within an advice business and have their own scoring systems which is akin to ‘witch doctoring’ with the client’s preferences,” he said.
“The failure of questionnaire based risk profiling can be seen in law suits against advisers who had risk profiling. The adviser may not have been wrong according to the risk profile but the position is indefensible because the adviser cannot place a statistical accuracy on how well they have actually profiled the client,” Del Rey said.
Del Rey said questionnaire based methods developed in the 1940s and have used questions to gauge an investors preferences but says more recent economic, technology and human behavior models allows investors to be “placed in a wind tunnel to analyse the investment choices they make and why they made them”.
According to Del Rey new developments in ‘game theory’ and decision making will allow advisers to identify client’s risk preferences by analyzing their decisions through a series of tradeoffs, or investment ‘games’.
He said this ‘revealed preference’ approach relied on client’s showing their actual positions in simulated circumstances as opposed to stating them to an adviser and better met client and regulator expectations around the basis for advice.
Del Rey said the difference between the two approaches was important because while clients may express a preference in a certain situation how much they were prepared to act to change or improve the situation varied greatly and was not revealed by questionnaire based risk profiling.
AUTHOR
Jason Spits
Recommended for you
ASIC has released the results of its first adviser exam to be held in 2025, with 241 candidates attempting the test.
Quarterly Wealth Data analysis has uncovered positive improvements in financial adviser numbers compared with losses in the prior corresponding period.
Holding portfolios that are too complex or personalised can be a detractor for acquirers of financial advice firms as they require too much effort to maintain post-acquisition.
As the financial advice profession continues to wait on further DBFO legislation, industry commentators have encouraged advisers to act now in driving practice efficiency.
