Suitability Explained

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A risk profile is a conduit between an investor and their investments; a means of determining if the investor’s willingness and ability to take investment risk is suitably reflected in their investments.

The key to investor risk profiling is to know which elements of an investor’s situation should affect their choice of investments, and which should affect only how those investments are viewed.

These elements must be robustly and independently measured, and the outputs put to work in their proper places, not asked to do jobs for which they weren’t designed.

Investor risk profiling

From compliance burden to client benefit

Knowing which suitability toolkit to trust as an adviser is a lot like knowing which adviser to trust as an investor. From the outside looking in, there are technical complexities to navigate, clear features but hidden benefits, and the stakes are high: life savings and the life goals they seek to fund are on the line.

At Oxford Risk we believe that there is a better way. Implementing a investor risk profiling process goes beyond box-ticking. Done properly, a suitability process should be a way to deepen adviser-client relationships and turn compliance chores into investor engagement.

Doing it properly means ensuring every element – risk tolerance, risk capacity, emotional comfort and knowledge and experience – is present and correct, and subject to a rigorous and robust methodology, grounded in quantitative and behavioural finance.

There’s no point being engaging if the tools don’t work as intended, or answer questions that shouldn’t even be asked. And there’s no point being perfectly reliable if no one understands what you’re being reliable about, or you’re adding to the complexity instead of helping to navigate it.

 

Improving decisions with behavioural science

Risk-profiling is traditionally seen as a static exercise. Something to be completed at the start of a relationship, to be reviewed infrequently and in no great depth thereafter. Its input to an investor’s journey is limited. When behavioural science is put at the heart of the profiling process, this view quickly changes.

Behavioural science is all about developing a deeper understanding. And it’s one everyone is usually happy to help with: we are all drawn towards finding out more about our inner selves. As with any scientific method, using behavioural insights in financial advice is a continual journey of experimentation and refinement: finding out what works and what doesn’t for a given client, or, more likely, a given type of client.

A dynamic investing journey demands a dynamic suitability process. And a suitability process that ignores or inadequately measures how each investor seeks emotional comfort along their investment journey – a question of their short-term behaviours, not their long-term risk tolerance – can hardly be called suitable.

 

A problem shared

The demands of a dynamic journey, as well as vastly increasing the richness of the investor profile can initially feel like adding to the burden, not removing it.

This, however, would be to misunderstand three key points:

  • Not all profiling has to happen at the same time– A sophisticated profile builds over time, incorporating information about changes to circumstances, and psychological reactions to new experiences, including an ongoing investment education.
  • Assessments can be largely automatic– A dynamic process would be much more time-consuming than a static one were all the inputs needed to be entered manually. With Compass, this is not the case. Much of the required information is collected automatically via API integration with existing systems. Built-in, not bolted on.
  • Profiling outputs can make other processes more efficient– Automatic risk-capacity calculations and behaviourally tailored communication can remove a lot of unnecessary guesswork about how to translate changes in client circumstances into either portfolio changes, presentation of information, or the frequency of client contact, among other things.

When the journey is dynamic, the process to monitor its suitability should be too. The client behaviours that define the comfort of an investment journey don’t stop when the portfolio starts, and don’t turn off between reviews.

It may also feel like the emotional state of an investor is no business of an investment adviser. For some, the doctor’s job is to diagnose and prescribe, not to ensure compliance with that prescription.

Again, however, this feeling rests on a misunderstanding of the aim of a suitability process.

Despite appearing to live in the cold, hard world of numbers, investing is one of the most emotionally provocative topics there is. And in terms of the monetary cost, in no other area is the gap between doing what we ought to do and doing what we do do potentially so expensive. These expensive mistakes are why the very concept of suitability exists in the first place. And the most expensive mistakes are just as often the effects of emotional causes as they are of investment ones.

 

A problem solved

Just as not all advice is created equal, nor are all suitability tools.

Some advice is based on evidence, some on hunches. Some is client-centred, sometimes clients are collateral to a different end.

Suitability is subjective: a risk profile is a subjective measure of suitability: investments are risky for an investor.

Regardless of differences in tolerance, the same portfolio can be very risky for someone relying on it for the majority of their future spending, whereas it may be not risky enough for someone whose spending is already covered by a secure income. The key question is in the quantification of these differences in a robust, reliable, and repeatable way. 

It is also crucial to isolate the measure of an investor’s long-term risk tolerance from their more variable behavioural traits. Without sufficient rigour in the compilation of a risk-tolerance questionnaire, it is all too easy to confuse the measurement of a hard-wired proactive willingness to risk poor outcomes by mixing in measurement of reactive behaviours likely to be experienced along the journey.

 

What can the best suite of suitability tools do for you?

The right tools work with you to enhance existing skills and give you back some of the time lost to the routine tasks that sit on the edge of your areas of expertise and interest.

Think of them as a form of ‘decision prosthetic’: a means of making people more consistently the best versions of themselves. Humans are irreplaceably valuable but also error prone and inconsistent; where these areas of inconsistency are systematic, it’s time to call in some support.

 

Contact us to learn more about how Oxford Risk’s behavioural-science expertise and suitability toolkit can:

  • transform your investor risk profiling process from a static compliance burden into a process as dynamic and client-focused as the investment journey it’s designed to assist;
  • in doing so free up time to allow you to focus on your client relationships, by automating certain tasks (e.g. data entry into suitability analysis tools, risk capacity calculation), and assisting with others (e.g. meeting preparation and content);
  • provide a greater consistency of advice across your firm and across clients, through a full suite of reliable, robust objective assessments;
  • provide a deeper insight into your clients;
  • use that insight for enhanced targeted messaging and personalised presentation, increasing client understanding, engagement and satisfaction, as well as their overall comfort with investing; and
  • save time and money, and future-proof best compliance practice by using a complete specialist suitability package that you can rely on to keep pace with regulatory changes.

 

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