Financial Planning

How should a Financial Planner Assess your Risk Profile?

Unfortunately, it is no longer surprising to hear of investors who have lost their savings due to receiving bad financial advice. One contributing factor is that, in the past, financial planners may not have had a reasonable basis for giving financial advice.

However, now with the Future of Financial Advice (FOFA) reforms, the legislation now enforces a “know your client” rule in order for financial planners to give the most appropriate financial advice. To better know their clients, financial planners should be undertaking a risk profile.

Read on to find out more about risk profiles and whether your financial planner is profiling you appropriately.

What is a financial risk profile?

A financial risk profile identifies and measures an investor’s attitude to risk. It basically assesses risk tolerance, to determine the level of risk the investor is comfortable with. Risk tolerance is specific to the investor, and will vary among individuals.

Financial planners are under a legal obligation to give advice only if there is a reasonable basis underlying the advice. Therefore, this risk profile forms the basis of the financial planner’s recommended investment strategies. Failure to undertake risk profiling of an investor can constitute financial planning negligence, as there would not be any reasonable basis for advice given.

How should a financial planner assess your risk profile?

Risk profiling should be undertaken during the initial stages of the financial planning process, before any advice is given. There is no set method of risk profiling, and the methods used can vary among different financial planners. Some risk profiling methods include:

Risk Profile Questionnaire

The most commonly used risk profiling tool is the Risk Profile Questionnaire. This is a series of questions, asked to determine the investor’s reaction to different financial outcomes. The investor’s response is then graded with a score. Based on the total score, the investor is classified into a category of investment style, ranging from categories such as “conservative” to “balanced” to “high growth”. Each category will have a description about the type of investor in that group, and suggested investment mix.

For example:

Investment StyleScoreDescription
Conservative0-10 Points
  • You are a conservative investor
  • You have a short investment time horizon
  • Your main objective is to safeguard your capital
  • You require stable growth
  • You are willing to take little to no investment risk
  • You are willing to sacrifice high returns for safety
  • Your return is likely to be low, but consistent
  • You should invest in 95-100% defensive assets, and 5-10% growth assets

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Risk Tolerance Line

Using usually a five or ten point scale, this asks the investor to indicate their preferred place on the scale. The scale ranges from low risk tolerance to a high risk tolerance.

Life-cycle Approach

This takes into account what life stage the investor is in. It assumes that a younger investor is more concerned with wealth accumulation and would have a more aggressive risk profile, and that older investors are more concerned with income and would therefore have a less aggressive risk profile.

Sensitivity Analysis

This tests how different outcomes would affect the investor’s financial capacity, for example how the investor’s financial capacity be affected if they suffered a capital loss, or if the expected return was not realised.

Accuracy and relevance of information

If the investor has not provided accurate information about their circumstances to the financial planner, then the financial planner will not be liable for advice based on the given information. Therefore, the investor should ensure that they give accurate details when undertaking a risk profile. While the investor does have the right to withhold personal information, the implication of this is that the advice the investor receives may not be fully appropriate for their situation.

Changes in your risk profile

Risk profiles tend to change over time. This can attributed to changes in the investor’s attitude to risk or changing personal circumstances, such as starting a family or buying a house. Therefore, risk profiles should be reviewed regularly. If you feel that your risk profile has changed, you should inform your financial planner as soon as possible.

Agreement upon risk profile

The investor must sign off on their risk profile, to signify that they are ready to proceed. This includes acknowledging the financial planner has explained the concept of investment risk to them, and that the risk profile determined by the financial planner is appropriate for their circumstances. If an investor feels that their risk profile is not the right fit, they are able to nominate another risk profile which they feel better reflects their circumstances.

What should I do if my financial planner has been negligent?

If you feel that your financial planner has not properly assessed your risk profile, or that any advice given was not in line with your risk profile, this may constitute negligent financial advice. For more information on financial planning negligence, contact Schreuder Partners today.

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