Our guide to assessing risk types

The Psychological Consultancy’s Geoff Trickey reveals why you should identify your own risk type before advising clients.

Provision of financial advice and management is a knowledge-based practice and, in a world where financial services and investment products grow ever more complex, most IFAs will have enough to do keeping up with market trends, red tape, legislation and good practice guidelines.

Yet, they are required to assess each client’s propensity for risk. Poor practices have already been highlighted by the FSA, which between 2008 and 2010 rated more than 50% of the files they reviewed as “unsuitable” due to shortcomings in the way the customers’ attitude to risk was assessed.

Pitfalls of people perception

Many people claim to be “a good judge of character” but the newspapers are a daily reminder of the difficulty of achieving more than a superficial understanding of others, even those we think we know well.

Intelligent, pleasant, even angelic faces smile at us from above captions reporting awful crimes. News articles tell endless stories of broken promises, deceptions, exploitations and betrayals. Interviewed neighbours and the close relations of violent offenders tell us how sweet, kind and inoffensive they had always seemed.

Hopefully, these are just the extremes, but accurate assessment of another person’s true nature, including their propensity for risk, is certainly a considerable challenge.

A further difficulty in assessing other people is we all tend to underestimate just how different others can be. We each protect ourselves behind a superficial veneer, a persona designed more for effect than for illumination. Courtesy, social conformity and the desire to impress all serve to obscure the true you.

Perceptions are further distorted by the tendency to use ourselves as the standard against which all others are measured. But, as the old Yorkshire saying has it: “There’s nowt so queer as folk.”

The reality is that no one, not even the FSA, has yet been able to properly get to grips with “human factor risk”. Who could have envisioned the levels of risk-taking indulged at Enron under Kenneth Lay, or the various escapades of Nick Leeson at Barings, Fabrice Tourre at Goldman Sachs, Jérôme Kerviel at Société Générale, or Fred (the shred) Goodwin at the Royal Bank of Scotland?

One positive outcome of the recent financial meltdown may be that it has dramatically highlighted the limitations of our antennae for human factor risk and created a climate for research and innovation. We are now beginning to get to grips with the crucial differences between risk types in a way that demystifies them and forewarns us of their potential consequences.

A typology of risk-taking

Research tells us the roots of our appetite for risk lie deep in our natural temperament. However, attitudes to risk are often more superficial and owe a lot to experience, current trends and personal circumstances that may either extend or diminish risk tolerance.

Recent research reveals eight distinct risk types, ranging from the wary type – whose sole agenda is security, right through to the adventurous type – who are impulsive and almost oblivious to risk.

The risk-type compass is a 15-minute questionnaire designed to provide the basis for a purposeful conversation between a client and their IFA, allowing informed decisions to be made about risk exposure and portfolio choices.