Far too many wealth advisers view risk profiling as an unnecessary box-ticking exercise, leading to poor client outcomes, according to behavioural finance experts Oxford Risk. Risk profiling is essential to providing good advice and ensuring regulatory compliance, but the profiling field is rife with misunderstanding and poorly designed assessment tools, Oxford Risk says.
Advisers far too often confuse clients’ tolerance of long-term risks with the unstable attitudes they display in response to short-term events such as market corrections over time.
“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,” says Greg B Davies, PhD, Head of Behavioural Finance, Oxford Risk.
He added: “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. Measuring the wrong thing is worse than not measuring at all.”
Oxford Risk believes the best investment solution needs to be anchored on stable and accurate measures of risk tolerance. Behavioural profiling then provides an opportunity for investors to learn about their own attitudes, emotions and biases, helping them prepare for the anxiety that is likely to arise … but these should be used to help investors control their emotions, not define the suitable risk of the portfolio itself.
Oxford Risk builds software to help wealth managers and other financial services companies assist their clients in making the best financial decisions in the face of complexity, uncertainty, and behavioural biases. However, it says that many wealth managers and financial advisers are poorly equipped to help clients deal with the emotional and psychological roller-coaster ride their clients have endured during the COVID-19 crisis, and the impact it has had on markets and their investments.
Oxford Risk has launched a free Market Emergency Survival Kit which allows retail investors to measure six key dimensions of financial personality, which the company has identified through extensive research into investor psychology and financial wellbeing. The service also provides personalised recommendations on how best to invest, which are based on the findings.
The company says there are behaviours that are common to many investors at such volatile and uncertain times. During a crisis, investors are likely to focus too much on the present and on the detail, feeling compelled to do something even when sitting tight is the best solution. They can gravitate towards the familiar – often leading to underinvestment, selling low, or decreased diversification.