Receiving investment advice is an act of trust – but how can you be sure that the advice you are receiving is tailored for you?
Author Gillan Williams
Date 27th September 2016
Fortunately, there are controls in place, enforced by the FCA, that help advisors maintain a high standard of care when providing advice. The first important consideration is assessing your risk tolerance.
All investment advisors, from Retail Banks, Wealth Managers and Independent Financial Advisors must assess your tolerance to risk, establishing your comfort level with risk of different investments and align your portfolio options accordingly.
However, our research shows that this is not enough. For a clear and accurate overview of your investment ‘personality’ and understanding of exactly which investments are appropriate, there are other factors that must be considered alongside tolerance. Below is an overview of the three main risk profiling factors to keep in mind:
- Risk Tolerance
- Risk Suitability
- Risk Capacity
This is measured through answering psychometric questions, devised through years of academic research and processed through an algorithm that determines your willingness to take risk, in a relative scale calibrated with tens of thousands of investors in the UK. This ensures that not only is your comfort with investment risk understood, but also where you are placed on the relative scale of investors.
This is a crucial and often omitted element of understanding which investments are suitable. Our studies show that whilst Risk Tolerance will remain stable over time, your risk preferences will not as they will be subject to external biases such as market sentiment, past investment performance and any range of personal views. Time plays a very important function too, the investment formats for 5, 10 and 20 year periods would be very different. Without understanding the suitability of an investment according to your preferences, it would be near impossible for an advisor to accurately match you to the right portfolio.
Understanding Risk Capacity is increasingly understood in the industry and is a vital consideration before undertaking any investment. Essentially, is it an assessment of whether investing is the right option considering your personal situation. For example, in certain situations it may be that paying off a mortgage may be a better proposition than investing money. Also, it is important to understand that there is a possibility of losing a significant portion of an investment. If this happens, how would that impact your current lifestyle?
Most financial advisors will assess your Risk Tolerance and Risk Capacity. It is advisable to find out whether your Risk Suitability is also being assessed to be certain you are receiving the most reliable and appropriate advice.
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