I have been in financial services for over 30 years and ‘attitude to risk’ (ATR) assessments, of some sort or other, have always been a thing during that period. Admittedly 30 years ago it was a tick box and every one was usually ‘balanced’. That said, I do not think the ‘sophisticated’ questionnaires in use today are much better at ‘assessing’ people’s real ATR. In fact I am not sure every planner really stops and considers what ATR is!
In my view ATR assessments are still assessing the wrong thing. We should be getting under the bonnet and questioning and challenging a consumers ability to withstand volatility. Or, as Twin 1 puts it, ‘the degree of risk that an investor is willing to endure given the volatility in the value of an investment.’
Prospect Theory 2 (or loss aversion theory) claims that we hate loss twice as much as we love gains. I am not sure if it is always true for everyone but in my experience I never received panicked calls from clients when their portfolio went up more than they expected!
Financial planners correctly ensure that consumers understand that all risk investments should be considered as medium to long term commitments (five years plus). And, in the calm before the storm, the majority of consumers agree. The problem is though we don’t live in years, we live and experience our lives day by day. As such, once the investment storms are raging, as they often do, customers feel the pain and experience natural fears of bigger losses. Sadly, we are not always logical beings and our emotions can overwhelm the strongest of us.
When exploring tolerance to volatility I believe we should be exposing consumers to actual real data that shows the largest losses that a portfolio their ATR is deemed suitable for. Many will be surprised to see potential losses in the 30+% range are common place for most portfolios. Even ‘safe’ bond investments, such as UK long term Gilts, suffered losses in this range during 2022.
Planners should definitely be on the lookout for evidence of ‘risk propensity’. The tendency to choose higher risk options with a low chance of success. Risk perception, especially following sustained increases in investment markets, can also skew the results of a ATR assessment. Likewise periods of investment falls can increase consumer nervousness (putting an end to any idea that any of the ATR assessments are really reliable).
Risk capacity and risk knowledge are obviously vital components to consider, ability to take on risk and risk literacy. However, one of the biggest determinations of ability to cope with investment volatility is evidence of previously doing so.
One of my biggest suggestion, other than searching for previous evidence of holding during volatile periods, is to use actual monetary values when discussing potential losses as opposed to percentages. Confronting a client with a graphic showing the consumer that their £100,000 could be shown to be worth £70,000 or less at some point during the next 12 months due to volatility will focus their mind to that fact that investment losses are only real when they are crystallised.