Since the release of the FCA’s (the FSA) guidelines on investor risk profiling, the requirements an advisor must follow to adhere to a compliant risk profiling process have been set out.
Author Gillan Williams
Date 5th September 2016
Many companies throughout the sector have since adopted new practices to understand the needs and personalities of their investors in a more consistent and accurate way. Have these initiatives, and their common understanding in the industry, been enough to provide consistency, accuracy and suitability of advice?
An investor’s tolerance for risk is certainly important to ascertain, but there are other, very important factors to consider. Risk tolerance provides a measure of the investor’s comfort with risk and the potential of loss. However, as a stand-alone indicator, it does not consider the investor’s capacity to absorb loss, or the impact that losses would have on their standard of living. As a first step to responsibly offer investment advice, an advisor must consider if the investor has capacity to even invest at all. For instance, those with no capacity at all (e.g. facing destitution if their investment is lost), may be better off clearing debts (such as paying a mortgage) before engaging with investments.
Suitability is also a vital element to consider in order to offer the most relevant investment options to clients. Whilst an investor’s willingness to take risk, as measured by their Risk Tolerance, is a good first step in the risk profile of an investor, it is crucial to validate what actual level of risk they will prefer. Preferences will vary significantly over time, and therefore a ‘best in class’ suitability analysis will continuously test investor preferences and will be informed by empirical research.
There are very few companies that offer this kind of service, or indeed understand how to accurately provide reliable results. Oxford Risk is a spin out company from the University of Oxford, benefitting from decades of behavioural and psychological research. Utilising psychometric questions and algorithmic calculations which reference hundreds of thousands of investor profiles, Oxford Risk can offer far more accurate investor risk profiling than any other system in the market. Furthermore, Oxford Risk has conducted investor risk preference research since 2011, and has been able to provide accurate, defensible and up to date indications of what suitable levels of risk map to which Risk Tolerance categories (and therefore which investments are suitable for which investor).
To help banks, wealth managers, networks and IFAs understand the importance of risk suitability and risk capacity, Oxford Risk have launched a website detailing how this applies to various investor types and what advice each type of investor should consequently be given. To find out more, go to www.oxfordrisk.com/investor-risk-profiling/risk-profiling-the-scientific-approach.
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