How to beat RDR six-love: A practical guide to customer risk profiling

In the fourth of a six-part series on preparing for RDR, Bruce Moss, strategy director at Advisa Centa, offers some advice on determining your clients’ attitude to risk.

Step 1

Psychometric risk questionnaire

Step 2

Scoring algorithm

Step 3

Initial risk profile assessment

Step 4

Capacity for risk assessment

Step 5

Stochastic forecast

Step 6

Investment recommendation

The FSA’s recent Guidance Note on establishing a customer’s risk tolerance and the suitability of an investment recommendation identified a number of serious shortcomings in the processes of many advisers. While the FSA’s analysis was generally good, it was short on practical suggestions, leaving the “difficult stuff” for the industry to work out.

A process which more than meets the FSA’s guidance is shown below.

It is not the only way that the process might work but all the elements need to be in place:

• An understanding of the attitude of the investor towards risk;
• An understanding of the investor’s capacity for risk, based on knowledge of the investor’s personal circumstances, experience and goals;
• Customer engagement from a discussion about the different types of investment risk and how the potential outcomes might affect the realisation of the investor’s goals; and
• A report and audit trail.

Psychometric risk questionnaire

A psychometric investment risk questionnaire is important in helping to identify the amount of risk that an investor is prepared to take. It can, however, only ever be a starting point for a discussion with an investor about his or her personal circumstances, financial goals and views about investment risk.