Risk: What would you advise?

Probably one of the worst questions you could ask a financial adviser when discussing your attitude to risk and therefore the make up of a portfolio. This is because those that work within financial services tend to have an above average attitude to risk, so in many cases the adviser would select a higher risk portfolio, often far higher. Now in fairness, this may be for good reason – for many people financial planning maths is about three components, how much you can put in, and the time before you need the money and the return required to “make it happen”. Invariably the wider population have considerable constraints on probably two of the three, time and contributions being the obvious weaker partners.

Risk PerceptionRisk

Risk is subjective on many levels – there are risks involved with anything, familiarity may well breed contempt in this instance. For example, most accidents happen at home or close to home, yet we tend to become more anxious when we travel abroad. Driving at speed increases the risk of a fatal accident. I recently heard that following September 11th, due to aeroplanes being grounded and the subsequent fear, many Americans chose to drive rather than fly within the US. This resulted in more traffic and more road deaths than were caused by the atrocity. I’m not certain that this is true, but is seems plausible and helps make the point about perceived risk.

Testing your attitude to risk

Risk may be subjective, but it is still possible to scientifically test attitude to risk using psychometric testing. Clients will know that we use FinaMetrica, the market leading psychometric profiling tool. This generates a very good report and useful discussion document, so that we can build a suitable portfolio for clients, where hopefully there are no surprises, good or bad. As if to labour the point, I recently did some work with Paul Resnik on our clients. Our results fairly accurately reflected the global population, but with a slight tilt towards lower risk in nature. On a global basis, most people (86%) score between 35-64 (around medium risk). In our case, this is 89% with fewer people in the higher risk categories. In very simple terms, most financial advisers would tend to use portfolio 6 (of 7) which is fairly aggressive, yet most investors are two rungs below in portfolio 4 (of 7) bang in the middle. So be careful what you ask for, unless your adviser properly assesses and discusses your attitude to risk, you may be taking more than you thought.

Dominic Thomas: Solomons IFA