Financial advisers should know clients’ risk tolerance

Globally, the financial crisis and market gyrations have unearthed several issues in relation to the selling of investment products. Some investors say they had been sold investments that were too risky. Others, who thought that they weren’t taking much risk, as the market was bullish, were caught by the steep slides in the values of their investments.

While risk tolerance doesn’t vary with the market, the perception of risk changes, says Paul Resnik, CEO of FinaMetrica, which provides psychometric risk profiling systems. Resnik was speaking at a behavioural finance luncheon talk organised by Deakin International Sdn Bhd, which specialises in psychology and behavioural finance tools.

One of the lessons he imparted is that there is a need for the financial adviser to be fully cognisant of the risk tolerance of his client. “Financial advisers tend to sell what they are most comfortable with, and they are generally more risk tolerant that their clients. Risk tolerance is often linked to overconfidence,” says Resnik.

The adviser should develop a financial plan together with the client, which should then form the basis for ongoing discussions, points out Resnik. “What I have been hearing from financial planners around the world is that clients are now asking them, ‘Why didn’t you tell me to sell when the market was at the top?’ The problem arises when the adviser allows the client to form a misconception of what he can do. If you can pick the top, what else can you do? Pick the bottom?”

While some quarters are asking for more regulation in the wake of several investing scandals and misselling claims, Resnik says it isn’t the answer. “Regulation in the US, the UK and Australia hasn’t stopped the mismatching of products. An extreme example is the selling of subprime loans to people who can’t afford them. Even with regulation, you can still check the boxes and get around the rules.” He advocates professional selling, where the adviser asks questions to find out what is needed by the client and the latter makes informed decisions, taking ownership of those decisions.

However, professional selling requires both buyers and sellers to be informed. “That’s the way it should be. You wouldn’t say to a car salesperson, ‘Here, take my money and do what you want to with it’. Why should you do that with an investment adviser? It’s imperative to self-educate,” he adds.

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