Most risk tolerance questionnaires get a bad rap. For many advisers, they are simply a compliance tool to appease the regulator. They add some value, but if it weren’t mandated, they probably wouldn’t use them. This negative mindset is rightly deserved due to the abusive use of risk questionnaires. Let’s get a few things straight…
- Risk questionnaires cannot tell you exactly how to invest.
- Risk questionnaires cannot cover the entire suitability process.
- Risk questionnaires cannot solely be used for prospecting.
The true purpose of a risk questionnaire is to help you know your client so you ask intelligent questions and recommend the best investments. Knowing your client entails understanding their goals, psychological risk tolerance, capacity for loss and behavioral biases. You cannot capture all of this in a questionnaire.
Investing should be goals driven but instead it’s compliance driven
Risk questionnaires should help you recommend investments and handhold clients during market ups and downs. Not prescribe allocations and securities. The FCA hinted this in their Financial Advice Market review published in March. A questionnaire cannot challenge a client’s misunderstandings or mistakes. This is what being an adviser is all about. Only you can do this.
The regulator has attempted to legislate trust between you and your clients but we know that’s impossible. It has resulted in the bizarre outcome where people are invested according to “what would pass an audit” instead of their long-term goals.
So what’s the solution? It’s twofold.
- Ultimately, the financial advice market will need to increase its standing in society so it has more trust and less need for regulation. Perhaps the greatest trust builder being increased education and professionalism across the ranks (which is happening). At the beginning of the last century medical doctors were widely decried for their quack cures and empty promises. A few decades later they were the most esteemed profession in the country. This can happen with financial advisers.
- On the risk tolerance questionnaire side, you should be ready to challenge the results of a risk questionnaire if it suits your clients’ greater long-term interest. Human judgment shouldn’t be completely dismissed. It just needs to be thought through and documented. Admittedly, going through a detailed question and answer session with a client is less efficient than a questionnaire but it will help you learn about your client’s overall profile in a way a risk questionnaire cannot.
As someone who leads a company that creates a risk tolerance questionnaire for advisers you might think it odd that I call out the limitations. On the contrary, I think this draws to attention the qualities and uses of an effective questionnaire. It should help you understand a client’s goals, psychological risk tolerance, capacity for loss and behavioral biases so you can ask intelligent questions and guide clients towards their goals. It should act as a client-friendly, 3rd party check in your process to ensure you don’t succumb to your own behavioral biases. Does your risk tolerance questionnaire do this?