TOP PLANNERS’ VIEWS
risk and develop a standardised methodology to quantify it.
Risk-profiling needs to comply with the principles of Treating Customers Fairly and the Financial Advisory and Intermediary Services Act.
Natasja Norval Hart, a wealth manager at GCI Wealth and the 2010 Financial Planner of the Year, says it is important for you and your financial adviser to have a conversation about investment risk.
In cases where the Ombud for Financial Services Providers ruled against advisers for failing to provide appropriate advice, the ombud considered more than the risk profile itself, but also the process the adviser used to determine it, the conversations the adviser had with the investor and the supporting documents the investor was given, she says.
WHAT DO THE TERMS MEAN?
One of the problems with riskprofile questionnaires is that they seek to determine if you are a conservative, moderate or aggressive investor, in the absence of a standard definition of what these terms mean. Some questionnaires seek to obtain more information and attempt to determine if you fall within one of five different profiles, including moderately aggressive or moderately conservative. Different asset allocations are then deemed to be suitable for each risk profile. Typically, if your profile is conservative, your allocation to equities is reduced, while your allocation to cash and bonds is high, and vice versa if your profile is aggressive.
Swanepoel says a dictionary definition of conservative is an aversion to rapid change; moderate means avoiding extremes, while aggressive means angry. With terms that are open to such broad interpretations, you and your adviser may have different ideas of what conservative, moderate and aggressive mean, he says.
He says the definitions and the
Norval Hart says the focus should not only be on your tolerance and capacity for risk, but also on your need to take risk. It is highly unlikely that these three factors will be aligned.
She says she discusses investments goals and objectives at her initial meeting with a client and leaves conversations about risk for later, because often there are too many things for you to absorb when you first meets an adviser.
She says once you and your adviser have a clear idea of your goals, you can have a fruitful discussion about the returns you need to target and the investment risk involved.
We often think we understand the impact of inflation on returns, but we underestimate the risk of investing too conservatively, and this is something you and your financial adviser should methodology used to determine what type of investor you are need to be standardised.
He says that when the FPI and FIA surveyed advisers, they asked them whether they regarded themselves as conservative, moderate or aggressive investors. They then asked the advisers what returns and what losses they expected their investment could make over any one-year period.
An adviser who identified himself as a conservative investor said he expected a return of 16 percent a year over five years, despite the fact that this is 10 percentage points higher than the inflation rate and totally unrealistic for someone who is invested conservatively.
Swanepoel says the same adviser was not willing to incur investment losses of even one percent of his investment over a 12-month period in order to achieve an average return of 16 percent a year over a five-year period.
An adviser who said he was a moderate investor stated that he expected a return of 25 percent a year, while an adviser who identified himself as an aggressive investor said he expected a minimum return of 12 percent a year.
Swanepoel says if advisers themselves do not understand the returns they can expect and the losses they could incur when exposed to different levels of investment risk, they cannot be expected to communicate this message to you.
Warnings about the inadequacies of risk-profile questionnaires have been sounded repeatedly over the past four years, but “nobody gave a damn and nothing has changed”. Risk-profile questionnaires are still “used slavishly”, Swanepoel says.
As financial advisers may be held accountable for advice they give and are compelled by the industry to use risk-profile questionnaires, the financial planning profession needs to do something about these flawed questionnaires, he says.
FPI members have been asked to comment on Swanepoel’s paper, which has also been sent to Bam.