In terms of FAIS, (the act that regulates financial advisors) an advisor is required to do a ‘risk profile’ for a client, specifically when it comes to investment. This regulation was clearly put in place to safeguard inexperienced clients from gung-ho brokers who had previously taken the life savings of little old ladies and put them into high risk investments, usually with the expressed desire to get their claws on fat upfront commissions. So… It’s a vital component of a financial plan – right? It isn’t that simple, and in fact can come with risks of its own.
Most of the ‘cookie cutter’ risk profiles that brokers use (Robo-Advisors) quite frankly do nothing more than cover the broker’s ass with the Financial Services board if the investment goes pear shaped and the client lays a formal complaint.
So what is important to consider?
- Objective of the investment. This is probably the most important variable, but is often omitted from a risk analysis. If it is retirement savings, often the largest component of a person’s ‘savings’ then that investment has to sustain the desired ‘draw-down’ or ‘pension’ when they come to retirement. If done early enough there are three basic variables that you can tweak to improve the end result.
- You can put away more, easier said than done
- Take less of a ‘pension’ when the time comes, a tough pill to swallow.
- Optimise the ‘asset allocation’ to get the best possible return. This is where there is the greatest risk from a poorly considered ‘risk profile’. If a broker decides that a client has a ‘conservative’ risk profile based on the check-box questionnaire, and puts the client’s investments into a conservative portfolio for years, or decades, then the client is going to suffer come retirement. An inexperienced broker may actually be unaware of the problem because cookie-cutter programs have to be manually adjusted for return variables that deviate from the norm and if a default is used then the numbers will look fine… until it is too late.
- The length of time the funds are going to be invested. This will affect the asset allocation of the product, and with it, the expected returns. For example, a short term investment should be in a conservative portfolio with ease of access and without penalties ( not shoe-horned into an endowment for example). Long term investments (8 yrs plus) can be exposed to as much equity as a client is comfortable with it – and has a good understanding of the risk of being too conservative.
- The portion of total investments the new investment forms part of. If it is the client’s entire life savings then clearly much more care needs to be taken to preserve the capital.
- The client’s understanding of investments, investment fees and asset classes. It is preferable to ‘collaborate’ with a client on their portfolio rather than let them abdicate their responsibility. If they do not understand the basic concepts of the different asset classes, interest versus growth, risk versus return, market volatility then my recommendation is start conservatively and work on skills transfer over time. Once these skills have been obtained, then you can make an investment less conservative. This is the value of annual reviews, detailed and personalised records of advice and constant client communication to allow for ongoing skills transfer. If you try and force the client into an investment they don’t understand, even if it is in their best interest, you are going to risk your reputation as a broker when they complain to the FSB. it just isn’t worth it
Actions: Know your risk appetite and the consequences; Review the asset allocation of your investments;
Author Dawn Ridler