How hard is it to really find out a person's appetite for investment risk? Is it enough to ask them directly or are there other ways to finding out less directly?
Top answer provided by:
Tim Henry
Most advice businesses have a formal questioning process that attempts to determine a client’s appetite for risk. However it is merely a guide and most definitely more discussion is required to gain the necessary insight.
It’s always interesting discussing investment risk with clients. There are many factors that can influence an individual’s attitude to risk and many of these are emotional factors. Past investment experiences, either positive or negative, are very strong influences. Clients may also be heavily swayed by peer discussion or the media, which may lead them to conform and neglect their own attitudes to risk.
It is really important to discuss the client’s emotions in more detail and to gain an understanding of how their opinions have been shaped. Investment Risk is a concept that does invoke emotions, so there is no point trying to take emotion out of the equation. However, our role as Advisers is to also bring facts and insights into the mix so that our clients feel empowered to make the decision that is right for them.
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Comments1
"Yes, all of the above, but nothing exceeds ignorance - fear of the unknown - when it comes to emotions. And as we know, emotion will almost always be dominant in determining action, and reaction. We talk of investment risk. Risk of what? In the vast number of investor cases (Mums & Dads, and everyday Superannuation savers) we are referring to risk of fall in market values of shares traded on the ASX and other (foreign) bourses. Yet, aren't we in the business of financial security; that is, peace of mind. Don't we know that 'the market' is simply a trading house, and by definition - certainly in the short term - speculative. Are we to base our Clients' financial security on mere speculation? Bearing in mind that unrealised capital gains (or losses) are nothing more than 'paper profits' (or 'paper losses')? What do we know for certain; at least what reasonable assumptions can we make in planning for the future? We know that notwithstanding the unlikely occurrence of large-scale wars, or world-wide natural catastrophes, economic life on planet earth will continue; that is, we shall continue to need food, shelter, clothing, transport and communications ability, plus all the means (banking, insurance, and information technology) of supporting the production of these requirements. And it is in the nature of economic activity that we continue to seek increasingly efficient economic activity; we call this economic growth; aka profitable economic activity. So, where can we find reasonable certainty of secure financial outcomes? Firstly, we can recognise that investment income (dividends, rental income and interest payments), plus realised capital gains are the only real investment returns; ie real 'show me the money' returns. Given continuing economic growth and attendant generation of investment income, we then have a reasonable assumption of funding a consistent, reliable and growing income stream (a retirement income stream). And to do this without the distraction of inevitable - and irrelevant - market volatility. Secondly, we could insist that all Superfunds report their investment income separately from capital value changes. We might then enable Superfund members to see that - despite the vagaries of money markets - their funds have a consistent income stream. If we become adept at explaining these facts, and more meaningfully report superfunds investment returns, then we take steps in overcoming the ignorance that prevails in typical investors' minds. And thereby lessen the fear and emotion that can be so costly to financial security and peace of mind. "
JayDub 10:21 on 30 Sep 15