Planner skill not enough to assess client risks
Financial planners relying on clients to provide information about risk appetites and aversion to loss are like doctors allowing patients to self-report their medical conditions and then treating them on the basis of that information.
Even relying on well-established adviser-client relationship is not enough either to ascertain these issues according to University of California, Berkley, Economics Department Chair and Capital Preferences, Chief Scientist, Shachar Kariv.
Kariv, who has been involved in research into behavioural and experimental economics focused on individual preferences and attitudes towards risk and time, said for many clients articulating what their preferences are around aversion to risk and loss was hard and that clients often used language and ideas differently than their advisers.
"It is like riding a bike, which people can easily do but it becomes harder to describe how it is done compared with showing how it is done," Kariv said.
"People have their own objectives and constraints and the question is how to meet those objectives within those constraints and then to create a portfolio."
He said survey based tools which assess risk tolerance, risk aversion and risk ambiguity but failed to have a mathematical base for what was included and produced was an inconsistent approach in financial services.
"We build things in many areas based on the best models, except in financial advice. If we collect data but have no basis for it, or create an arbitrary basis for it, then the range and rating of that data has no meaning," Kariv said.
"As a result, clients can be wrongly classified and assessed and advisers have no real basis to prove why they the risk position of a client was assessed in the way it was."
"There are norms in all professions that are universally accepted, but the idea that an adviser can understand their clients purely by their own skill and entrepreneurial approach is hubris and wrong."
AUTHOR
Jason Spits
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