The questionnaires financial advisers typically use to give you investment advice, assess your investment-risk profile and categorise you as a conservative, moderate or an aggressive investor, are fundamentally flawed and result in inappropriate advice being given.

Anton Swanepoel, a director of Amity Wealth and author of two industry papers on the topic, says that although risk profiling has been a source of much debate over many years, but it is only getting the attention it deserves now.

Swanepoel, who is also a director of the Financial Intermediaries Association, says FIA warnings about the questionnaires, supported by the Financial Planning Institute, have resulted in the establishment of an industry committee to investigate the problem.

He says FIA and FPI surveys conducted in 2015 revealed that more than 87% of 554 authorised investment advisers participating in the survey expressed the opinion that the questionnaires were insufficient for providing appropriate advice to investors.

‘Open to interpretation’

The industry committee, formed in 2016, consists of representatives of the FIA, the FPI, Masthead, the Association for Savings and Investment South Africa and the Financial Services Board.

Swanepoel points out that financial advisers have voiced their concerns about the quality of the questionnaires over many years .

In 2012, the Financial Advisory and Intermediary Services ombud, Noluntu Bam, also referred to the issue in her annual report when she said: “All too frequently, we encounter a disconnect between a complainant ’s risk tolerance, as calculated according to questions laid out in a risk profile document, and [the] complainant’s actual circumstances.”

Swanepoel believes that there are many reasons that risk-profiling questionnaires and practices should be investigated, and highlights three of his major concerns.

“Firstly, risk is not properly defined from the investor’s point of view. Secondly, not all the questions in many of these risk-profiling questionnaires are relevant to the investment at hand.

“Thirdly, risk is not quantified; and, typically, the categories in which investors are classified as conservative, moderate and aggressive are vague and therefore open to interpretation.”

He says determinations by the FAIS ombud support these concerns and that the FSB ’s appeal board has recognised one of the FPI’s main concerns. This is that categorisation of risk profiles in terms such as “low ”, “moderate ” and “high ” is relative.

Swanepoel adds that the FIA has concluded a comprehensive analysis of the subject and submitted its findings.

It is hopeful that the committee will be able to agree on a sound risk-profiling framework that will better serve the interests of investors in the years to come.

Francois Moller, head of technical support at PSG Wealth, agrees that traditional risk-profiling methods have their weaknesses.

They tend, for example, to focus too much on risk tolerance, an emotionally driven measure of an investors’ ability to stomach volatile returns in the short term.

Don’t be so emotional

Many studies have also shown that risk tolerance can be quite fickle — after a good run in the market, most people are more optimistic and less worried about short-term volatility.

But the opposite happens after a market slump, he says.

Although volatile markets can be scary to navigate, not taking enough investment risk could have devastating effects on the value of your investments in the long term.

Growth assets such as equities are volatile in the short term, but in the long term they are the best match for inflation, Moller says.

Discovery Invest general manager Craig Sher says the effectiveness of the risk-profile assessment depends on the questionnaire that the adviser uses.

Questionnaires that include only emotional-type questions, such as whether you like bungee jumping — to assess if you are an aggressive investor — are irrelevant to creating the right investment strategy for you, he says.

Questions about your time horizon are more relevant.

If you are able to invest for a lengthy period, you can afford to take on more risk to reach your investment goals than if you have a short time horizon, he says.

Riding out volatility

Discovery Invest makes use of a carefully designed questionnaire. It elicits responses that measure both the risk capacity and risk tolerance of an investor.

Any suggested strategy is therefore contextualised, because investors will know how much risk they should take, as well as how they are most likely to feel about the strategy during the ups and downs of the investment.

Although they might feel anxious during times of market volatility, they will then know that this should be expected from a strategy designed to achieve their longer-term end goal, Sher says.

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