As part of our role as outsourced paraplanners, we take time to make sure we're familiar with the kind of complaints being upheld against advisers and planners.
We do this using the decisions and case studies section on the Financial Ombudsman Service (FOS) website.
What comes up time and time again is that the client hasn't been adequately risk profiled, or that the client did not agree with the result of the risk profile.
We tend to see similar examples of poor practice:
- Partners being considered to have the same risk profile as each other despite only one party completing the risk profile.
- Clients not having sufficient knowledge and experience to have been invested in the products they are.
- Clients with insufficient capacity for loss or cash reserves.
- Advisers not reading the answers to the questions on the risk profile.
The key to using risk profiling tools is that they should be a starting point, not the answer.
While some might disagree with that statement, what they may not realise is the majority of risk profiling questionnaires do not consider a client's capacity for loss - and nor should they.
Meanwhile, some questionnaires include questions about capacity for loss despite this having no impact on the tool's output.
The potential missing elements
It's worth bearing in mind that a risk profiling tool provides only one of five elements needed to establish how to invest clients' assets.
The different elements are knowledge and experience, capacity for loss, the need to take risk, time horizon and attitude to risk.
All of these aspects should be considered in isolation and then in conjunction with each other.
No one aspect trumps another, which is why the different components need to be discussed with the client in order to identify which is more important.
Knowledge and experience
Demonstrating this can be challenging.
In the sad case of British Steel, it was clear to both the FOS and to claims firms that many steelworkers had very little experience of pensions and investments, and to suggest otherwise was wrong.
Capacity for loss
Capacity for loss is something I write about a lot.
I saw a succinct definition in a recent LinkedIn post, which described capacity for loss as “an assessment of how much a client might have to rely on invested assets in the event of a crisis.”
We typically assess this by examining what sources of income the client has, how secure is that income and how much of the client's essential spending that income covers.
This forms the basis of our assessment together with other factors such as the amount of assets they have, the client's cash reserves, and the protection they have in place.
Need to take risk
This comes down to the simple question of whether the client needs to take risk to achieve their objectives.
Just because they don't need to, that doesn't mean they shouldn't invest. But does the client understand they don't need to expose themselves to risk to achieve what they want?
Some will argue that by not investing they are exposing the client to another form of risk, that of inflation.
While this is true, we still consider this question of client understanding within our model.
Again, this is fairly simple to assess when examining clients' objectives, but an important aspect nonetheless.
If the client's goal is in five years’ time, and the risk of not achieving the objective could make a material difference to their lifestyle, then advisers need to consider the very real prospect of it not being suitable for the client to invest.
Attitude to risk
Attitude to risk is largely addressed by the different risk profiling tools available, but again, risk profiling alone is not the answer.
Clearly, everyone is different. No one tool will be perfect for everyone, which is why discussing the output with the client is so important.
For the advisers we work with, we recommend that they ask the client to write down in their own words what the output of the risk profile means to them.
This may seem over the top, but I don’t think any adjudicator could argue a client didn’t understand the output of the risk profile if the client's own words clearly demonstrate they did understand.
Sense checking the results
What we also see quite a lot is advisers looking at the risk profiling output, rather than the actual answers to the questions.
Consider the following statements and answers:
“I'm not comfortable with the ups and downs of stockmarket investments” – Agree
“I've little or no experience of investing in stocks, shares or investment funds” – Agree
“Usually it takes me a long time to make up my mind on financial matters” – Agree
“People who know me would describe me as a cautious person” – Agree
You might be surprised to learn that the seemingly cautious output from this risk profile questionnaire resulted in the client being rated as a balanced investor, or a risk score of five out of a possible 10.
While you haven't seen the answers to all of the questions, with your FOS adjudicator hat on would you really consider the client to be a balanced investor?
Advisers have a tough job in navigating the huge array of rules and regulations we all need to abide by.
But hopefully the point still stands that the answers to the risk profile need to be discussed, explored and documented.
These answers, plus the other factors, then need to be considered jointly to arrive at an outcome that the client feels comfortable with, and in order to help the client meet their objectives.