Financial advice

Assessing Investment Risk – Part 2

This article was originally published on Juno Wealth’s website. Juno Wealth was acquired by Progeny in February 2019.

Jumping across gorge

In our previous blog post in this series, we explained how and why psychometric testing is such an important part of our financial planning process. It remains a complex area and one that is often misunderstood, and in this article, we’re going to have a quick look at some of the pitfalls of using “in-house” risk tolerance questionnaires and why we have chosen to use the FinaMetrica investment risk profiling tool.

What’s wrong with “in-house” risk assessment tools?

All financial advisers and financial planners have an obligation to ensure the investment portfolio they are recommending is suitable for the client. Advisers and financial planners are also required to assess a client’s risk tolerance. Unfortunately, however, there is very little guidance or regulation of how to assess this. The result is an area which is fraught with potential for error. In fact, a 2011 survey by the Financial Conduct Authority into risk tolerance questionnaires found that 9 out of 11 were flawed in some way.

All financial advisers and financial planners have an obligation to ensure the investment portfolio they are recommending is suitable for the client.

Understanding the process

Assessment tools come in many shapes and sizes and can be (but shouldn’t be) complex. So, as a starting point, it’s really important that the adviser or financial planner thoroughly understands the nature and scientific basis of the assessment tool they are using as well as the products they are offering. Unfortunately, this often isn’t the case.

The adviser or financial planner needs to fully explain the process to the client and be able to interpret the answers, giving each answer appropriate weight. The adviser also needs to ensure they have a robust process in place which spots inconsistent answers, and which ensures investment selection does actually follow the preferences revealed by the assessment as well as taking into account the client’s objectives and financial situation. Again, this is often not the case.

The importance of independence

Another major problem with in-house risk tolerance tools is that they’re often not independent and may have been configured specifically with the provider’s products and funds in mind. This in turn can also skew the results with providers inadvertently tailoring questions or influencing answers and particular products becoming the preferred option. As a red flag, if the assessment tool is “free” then it’s often a sign that it’s not independent and may not be as transparent as it should be.

How we ensure that we are using a risk tolerance test that is fit for purpose

It’s all too easy to overlook the research and data behind a psychometric test. In order to ensure the test you’re taking is a good one, you need (or your adviser needs) to check and understand how the test was developed. It ought to be transparent and easy to understand from the test’s supporting material. It often isn’t.

It’s all too easy to overlook the research and data behind a psychometric test. In order to ensure the test you’re taking is a good one, your adviser to check and understand how the test was developed.

A good risk tolerance test should have been developed using established scientific principles to ensure the validity and reliability of its results. This involves testing and retesting a large pool of questions. A good risk tolerance system will also allow for the treatment of couples separately, as couples often have different risk tolerances – sometimes significantly different. The test or tool should also be tuned to the specific objective in mind rather than a blanket attitude to risk and return.

Why did we choose FinaMetrica?

We put a lot of research and time into choosing the best risk tolerance profiling tool. We wanted one that was independent, easy to use and to understand and was backed up with strong, scientific evidence.

We chose FinaMetrica, the pre-eminent global provider of risk tolerance assessment tools. FinaMetrica was founded in 1994, although the teams’ financial experience and expertise dates back to the 1980s and before.

Following the financial crash of the 1980s, founder Paul Resnik set out to turn the measurement of risk tolerance from what was at that stage little more than an art (and still is in some scenarios) into a science – by measuring it scientifically.

The development of the FinaMetrica test

The test took 4 years to develop and originally involved 25 questions. These are updated regularly. Over 150 questions were tested originally as were over 500 responses and FinaMetrica have conducted over 1.2 million tests. They retest their data every couple of years and have worked alongside the University of New South Wales and the London School of Economics in order to formulate an accurate test. And of course, they meet UK regulation and compliance requirements.

The test has been used by over a million users in over 20 countries worldwide but only takes about 15 minutes. The supporting material and technical manual supplied by FinaMetrica are comprehensive but easy to understand. Importantly, the FinaMetrica test also provides feedback on how people answer the questions which means it is easy to identify any inconsistent answers.

Finally, it’s clear when you hear founder Paul Resnik speak that he remains as passionate about improving standards today as he did 20 years ago and when we first identified FinaMetrica, it was clear their values are aligned with ours.

Psychometric testing has come a long way in the financial sector in recent years and we’re proud to be offering what we think is one of the best, if not the best risk tolerance test available. More importantly, we’re delighted that we can offer our clients this extra tier of both value and reassurance when it comes to investing their money.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and the value of investments can fall as well as rise. No representation is made that the stated results will be replicated.

Author Tracey Evans

Associate Director, Wealth

Tracey is passionate about helping clients to see their ‘big picture’ and has been doing so for nearly 30 years.

Learn more about Tracey Evans