INVESTING RISK TOLERANCE
tolerance is the willingness of an individual
totakeonrisk,whereasriskcapacityismore
about their financial ability to endure any loss.
Thetestscanrangefromsimplequestion-
naires to psychometric tests. “There are vari-
ations in the tools being used. I’ve seen some
basicteststhatmighthavehalfadozenora
dozen questions. They would be quite simple
andperhapsnotascomprehensiveasmost
adviserswoulduse.Itmightplaceinvestors
intoanumberofdifferentinvestorbuckets
from highly conservative, conservative to
balanced, aggressive and highly aggressive.
The terminology might vary but the principle
isthesame,”hesays.
Agoodadviser,however,willtrytogo
to a deeper level and “identify some of the
uniqueness of the individual; their unique
personal circumstances, their unique behav-
ioural traits, their unique attitudes, their
unique preferences, and refine the list of
investment opportunities or strategies that
maybeappropriate.”
Heggen says some of the psychometric tests
canrevealquitealotaboutourpersonality.
“Itcanbeamazinghowaccuratetheycanbe
when you start to read through the profile.”
Nature and nurture
FinaMetrica’s risk-profiling system is regarded
as world’s best practice and is used by financial
plannersin23countries.PaulResnik,co-founder
and director, explains that risk tolerance is
a personality trait that rarely changes. “Risk
tolerance tends not to change over time. It’s
settled, generally, by early adulthood and it’s
a mixture of nature and nurture. By the time
you’re in your early 20s it’s probably settled
forlife,”hesays.
But what does change is an individual’s
riskperceptionandriskbehaviour.“Risk
perception is how people feel about the market
atanyparticulartime.Andriskbehaviouris
what they do as a consequence.”
HecitestheGFCasanexample.“People
were investing heavily into equities in 2007
andunwindingtheirequityportfoliosin
2009-10.Nowallofthesensiblebehaviour
says that what they should have been doing
wastakingprofitsin2007andrebalancing
theirportfoliosin2009andbuyingmore
equities at cheap prices.”
Agoodadviser,oneyou’velearnttotrust
andrespect,couldhavebeenastabilising
influence and saved you from decimating
yourwealth.Thisiswhereavalidandreliable
risktolerancetestishelpfulforadvisers,says
Resnik. “If having done the test you discover
someonehasalowrisktolerance,buttheyare
young and they have substantial ambitions to
live well in retirement, you know you have a
tension to resolve.”
One of the greatest issues the industry
hasislackoftrustbecausepeoplearetaken
bysurprise,hesays.“Wehidevolatility,we
don’ttalkaboutuncertainty.
“You might say to this client, ‘Let’s start off
with a portfolio that’s at the riskier end of your
risk tolerance. Because markets are relatively
unpredictable, they go up and they go down,
let’stryandincreaseitovertime.’Whatwe
aretryingtodoisgiveyoutheconfidenceto
stay [in it] when you have a larger amount in
the market when it’s material to do so.
“Whatwearebasicallysayingisthebest
return you will get is by having as much equity
exposureasyoucanlivewith.Iftheyhavea
low risk tolerance, they will likely panic and
destroyvalue.Soit’sbettertohavetakeninto
account their risk tolerance than paternalisti-
cally saying, ‘I know what’s best: you should
be fully exposed to equities.’
“What you are trying to build as an adviser
is trust. Listening to your client, taking into
account their risk tolerance, you need to frame
their expectations: ‘It’s not largely consistent
with your financial needs, you need to take more
risk, but there’s nothing wrong with starting
with the risk you are comfortable with.’ There
should be no surprises in financial advice.”
FinaMetrica works with universities around
the world and its intellectual property is inter-
national. “We did our original psychometric
researchwiththeUniversityofNSW.Wenow
work with the London School of Economics,”
says Resnik.Self-starter
Last year the Financial Planning Association
launchedabasicriskprofiletestforitsDare
to Dream campaign. Ben Marshan, the FPA’s
policy head and a certified financial planner,
says it gives consumers some information
abouttheirfinancialpersonalitytype.(He
gothismumtodoit–seecasestudy.)“It
givesthemabetterunderstandingoftheir
biasesbasedonwhichoffourriskcategories
they fall into and helps them understand
howitmightimpacttheirfinancialfuture.
Weviewitasfunquiz–itgivesyoualittle
insight into yourself and that will hopefully
spark an interest in your financial position.
“Yougetpeoplethatthinktheyarealot
more conservative than they actually are
and need to be. And you get the other camp,
people that think they are aggressive investors,but when they sit down and do the test they
findtheyaremoreconservativethanthey
thought they were.”
Marshan says a financial planner would
gothroughasimilartest.“That’showthey
decide whether or not you are somebody who’s
happy to take a lot of risk or someone who