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Risk, Risk Profiling and Risk Tolerance.

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Risk Behaviour Doesn't Change Risk Tolerance

FinaMetrica Pty Ltd - Wednesday, 24 May 2017

There's an increasing interest in risk profiling around the globe. We now have several competitors. Many new risk profile providers must feel obliged to provide a new insight that shows their research revealing established views (often FinaMetrica's views based on our almost 20 years and over million test experience) as wrong. Unfortunately their conclusions can be based on flawed thinking or flawed inputs. This is a recent example, and our response, raised by a Sydney based subscriber.

“I was at the Morningstar conference and a presenter commented along the lines that: "...the value of risk tolerance profiling is questionable at best because research shows that clients with a high risk tolerance don't behave accordingly. Clients with a low risk score are the ones that stay the course (according to what their profiling questionnaire revealed)". To this point then I am interested to know if you have any research that shows the percentage of clients that behave differently to what their profile suggests.”

We are not at all surprised by the Morningstar research as we have reservations about the outputs of their risk profiling. In particular, their risk profile appears to ask a combination of risk tolerance, risk capacity, time horizon and experience questions (a combination of psychological and financial questions).

It is well documented that psychological and financial attributes cannot be assessed together, they need to be separated and then mapped to a common parameter so that informed trade-offs can be made. If they are assessed together then the result is an average that is not at all useful to the client or advisor. Here's a simplistic example, someone with a long time horizon and a low risk tolerance will be given the same outcome as someone with a short time horizon and a high risk tolerance and we know that these two clients require different strategies.

Furthermore, many (as seen by Morningstar) often mistakenly “equate” risk tolerance with risk behaviour and interpret changed risk behaviour as changed risk tolerance.

Just because someone’s behaviour has changed doesn’t mean that their risk tolerance has changed. Behaviour in risky situations will not be a function of risk tolerance alone. Goals, the perceived risk, the perceived alternatives, the level of trust in an advisor if one is involved, etc. will all play a part. We know that risk tolerance is stable - even through a Bear market (see reference below).  When behaviour changed in the last Bear market, it was much more likely to be because perceptions of risk had changed. Clients (and many advisors) simply had no idea that what did happen could happen. Perceptions of risk can change in an instant. Questioning advisors who say that their clients’ risk tolerance has changed usually leads to their agreeing that this view is an assumption based on observed behavioural change.
A more likely explanation of why people may not stay the course is that risks and trade-offs were not properly assessed and explained and you have a miss-match. That is, the questionnaire used is not reliable or accurate and the risks in the product is not properly explained and people are surprised. When people are surprised they react accordingly, as described by Robert Kiddell during the 07 bear market.

"Our practice is divided into two teams – ours uses FinaMetrica, the other does not. Our team has observed FinaMetrica's worth because our team's clients stayed in their seats for the 2007-09 rollercoaster ride, whereas a number of the other team's clients have abandoned their seats at or near the bottom."

Robert Kiddell CFP
McMillan Financial Planning Pty Ltd

Reference: Roszkowski, M. & Davey, G. (2010). Risk Perception and Risk Tolerance Changes Attributable to the 2008 Economic Crisis: A Subtle but Critical Difference, Journal of Financial Service Professionals, July, 42-53.
Grable, John E., Wookjae Heo, and Michelle Kruger. 2016. “The Intertemporal Persistence of Risk Tolerance Scores.” Journal of Financial Planning 29 (8): 42–51.


Posted: 24/05/2017 10:06:16 AM by FinaMetrica Pty Ltd | with 0 comments

New risk score mappings to Vanguard LifeStrategy® Funds

FinaMetrica Pty Ltd - Friday, 19 May 2017

FinaMetrica is delighted to have mapped the Vanguard LifeStrategy® Funds to our risk tolerance scores, allowing advisors to easily select the right portfolio to suit their client's individual need.

What sets Vanguard apart – and lets Vanguard put investors first around the world – is the ownership structure of The Vanguard Group, Inc. Rather than being publicly traded or owned by a small group of individuals, The Vanguard Group is owned by Vanguard’s US-domiciled funds. Those funds, in turn, are owned by their investors. This unique mutual structure aligns our interests with those of our investors and drives the culture, philosophy and policies throughout the Vanguard organisation worldwide. As a result, global investors benefit from Vanguard’s stability and experience, low costs and client focus.

Vanguard LifeStrategy® Funds include a family of portfolios with different levels of potential risk and return. Each fund offers a diversified blend of stock market equities and bonds, built using Vanguard’s underlying cost-efficient index funds. They provide professionally constructed and diversified portfolios designed to help your clients meet their goals, whatever their attitude to risk.

Find out more about Vanguard LifeStrategy® here.

Posted: 19/05/2017 4:17:36 PM by FinaMetrica Pty Ltd | with 0 comments

Mapping of the Momentum UK Managed Portfolio Range

FinaMetrica Pty Ltd - Monday, 24 April 2017

FinaMetrica is delighted to announce that the Momentum UK Managed Portfolio range is now mapped to the FinaMetrica risk tolerance scores.

The Momentum Managed Portfolios are an outcomes-based solution designed to give investors access to discretionary investment strategies. These solutions are structured to provide a sophisticated investment offering that aims to perform strongly in an array of market conditions and is very competitively priced. This Managed range consists of six Managed Portfolios designed to cater for a wide range of risk and return appetites. All the Portfolios utilise our investment desk’s macroeconomic views, asset allocation framework and contain investment instruments carefully selected by the team from leading global financial institutions.

The Portfolios target inflation plus returns over four or more years. They are broadly diversified investing in a range of equities, fixed income, cash, property and alternative strategies. The Portfolios’ asset allocations are actively managed and reflect Momentum’s views on asset classes, regions and currency. These can be implemented using either active or passive strategies. The Portfolios are also rebalanced on a regular basis to ensure that the asset allocations adhere to the original risk profiles.

For more information, visit:

Posted: 24/04/2017 10:39:38 AM by FinaMetrica Pty Ltd | with 0 comments

Risk Tolerance Assessment Misconceptions

FinaMetrica Pty Ltd - Friday, 21 April 2017

We recently had a request from a long term subscriber John Reilly, the Managing Director of Good Will Financial Services in Bristol to assist in his ongoing due diligence of FinaMetrica's risk profiling integrity..

"Through normal due diligence research, I read this article with an open mind. It became strikingly obvious, when I read a couple of their examples of ‘poor practice’, that they were talking about FinaMetrica (without naming the innocent!). I would be grateful if could respond to these ‘criticisms’ and the other aspects they raise."

We responded:

We see articles like this pop up now and then and while well intended they tend to confuse the subject matter further. Most of the concerns stem from a poor understanding of what risk tolerance is and how it fits into the risk profiling process and psychometric testing. We’ve provided two examples below.

The article references the FCA (FSA), paper in 2011. We reviewed the FSA paper and wrote to the FSA to clarify some of the misconceptions around risk tolerance assessment and psychometrics. You can read our comments here. We had no response from the FSA and the guidance was finalised a few months later with no meaningful changes.

Our view then and remains now that the FSA paper was a good start to improving risk profiling but set a very low standard. We reviewed all of their comments and decided that we could only reduce the effectiveness of our test if we followed their 'advice'. Hence we’ve made no changes on our end.

For example 1:

Extract from :

Compared to others, how much of a risk taker are you?This question requires the client not only to make a judgement about themselves based on undefined and subjective multiple choiceanswers but also to make a judgement about others. It is an impossible question!

Roszkowski (1992) commented that “another ostensibly straight forward approach to assessing risk tolerance involves asking the client to classify himself or herself with respect to the amount of risk that he or she can tolerance”. It should never be the sole basis for determining a client's risk tolerance, but along with other items, a global self-rating adds to the assessment process because it captures elements that the other items may not be able to tap.

Furthermore, the research literature shows that people can to some degree estimate their own risk tolerance among others. Grable et al (2006) conclude: "Self-assessed financial risk tolerance was found to be a statistically significant predictor of general financial risk tolerance, cash holdings, and equity holdings, both by itself and when analysed using control variables. The amount of variance explained by self-assessed risk tolerance, by itself, ranged from 2% for cash holdings to 27% for general risk tolerance." In a study using The American College's Survey of Financial Risk Tolerance, Grable and Roszkowski also found that the correlation between self-assessed risk tolerance and risk tolerance as assessed by the other items in the test to be .41.

The LSE analysis of FinaMetrica data shows that the self-rating questions scored very well. They have high correlations with the other items and load strongly on the risk tolerance factor and Doehman (2005) paper provided strong evidence regarding how predictive a global self-assessment of risk tolerance can be.

For example 2:

Extract from :

Is it more important to you that your money keeps its buying power or that you dont suffer a loss?This question expects the client to compare two non-opposing factors.Maintaining buying power is not the oppositeof not suffering a loss. It is like asking, Do you prefer vegetables or holidays?

The question as presented is poorly worded and requires the contextual explanation before it.

We agree with the article that risk profiling is the start of a conversation, a discussion piece; however, the measurement of risk tolerance should be done using a proven scientific discipline like psychometrics.

Advisers are responsible for the processes and tools used in formulating advice. Advisers must satisfy themselves that, at a minimum, any tool used is both fit for purpose and true to label. Our Due Diligence Checklist is designed to help you conduct due diligence on any risk tolerance test in the market, including ours, we’ve completed one for FinaMetrica at the end of the checklist for you.

Roszkowski, M. J. How to assess a client’s financial risk tolerance: The basics. Personal financial risk tolerance. Bryn Mawr, PA: The American College, (1992) pages 6 to 7.

Grable, J., Roszkowski, M., Joo, S., O’Neill, B., & Lytton, R. How Well Do Individuals Assess Their Own Risk Tolerance? An Empirical Investigation. Consumer Interests Annual, (American Council on Consumer Interests), (2006), 52, 229

Dohmen, Thomas J., et al. "Individual risk attitudes: New evidence from a large, representative, experimentally-validated survey." (2005).


Posted: 21/04/2017 3:51:05 PM by FinaMetrica Pty Ltd | with 0 comments

Professional Judgement and Risk Profiling

FinaMetrica Pty Ltd - Friday, 03 March 2017

University of Georgia (UGA) Research Project

FinaMetrica supports the advancement of financial planning by promoting and in some cases performing fundamental research in the field of financial planning. It is our pleasure, together with PlanPlus, an alliance partner, to participate in a research project with Dr. John Grable and his team at the University of Georgia to better understand the role of professional judgement in arriving at an investor risk profile.

The survey will only take around 15 minutes to complete and your participation is much appreciated. Below is a message from UGA and Dr. Grable explaining the research in more detail.

From UGA and Dr. John Grable
You are receiving this invitation to complete a survey about risk profiling because of your expertise in financial planning. My colleagues and I are collecting feedback from a sample of financial planning professionals about the factors used to shape a client’s risk profile during the portfolio development stage of the financial planning process.

I anticipate that it will take you 15 minutes to complete the survey. When you click on the link you will be asked to evaluate three to five scenarios. You will also be asked to provide some information about your practice.

Getting to the survey is easy. Simply follow this link:

As a study originating at the University of Georgia, I want to assure you that your responses to the questions asked will remain confidential. No identifying information about your personally will be saved or coded in the dataset. Here is more information about your rights as a survey participant:

I am a professor in the Department of Financial Planning, Housing, and Consumer Economics at The University of Georgia. I invite you to participate in a research study entitled Financial Risk Profiling. The purpose of this study is to identify elements of the risk profiling process and to determine how financial planners use risk profile scores when forming portfolio recommendations.

Your participation will involve reviewing a set of standardized scenarios and ranking the inputs that you consider important in shaping a client’s risk profile. An additional element involves making a portfolio allocation recommendation. The survey process should only take about 15 minutes. Your involvement in the study is voluntary, and you may choose not to participate or to stop at any time without penalty or loss of benefits to which you are otherwise entitled. My team and I plan to analyze the collected data and publish the results in outlets such as The Journal of Financial Planning, but your name or any identifying information will not be used. In fact, the published results will be presented in summary form only.

If you decide to stop or withdraw from the study, the information/data collected from or about you up to the point of your withdrawal will be kept as part of the study and may continue to be analyzed. Do note that this is a confidential study and only my team and I will have access to data. We have plans to secure the data by removing any identifiers to respondents. The findings from this project may provide information on the way financial planners conceptualize client risk profiles. There are no known risks or discomforts associated with this research. At the end of the survey you may request that you receive a summary of the findings.

If you have any questions about this research project, please feel free to email me at: or call me at 706-542-4758. Questions or concerns about your rights as a research participant should be directed to The Chairperson, University of Georgia Institutional Review Board, 609 Boyd GSRC, Athens, Georgia 30602; telephone (706) 542-3199; email address

By continuing with the survey, you are agreeing to participate in the above described research project.

Thank you for your consideration! Please print and keep this letter for your records.

Sincerely, John Grable, Ph.D., CFP®


Posted: 3/03/2017 10:38:03 AM by FinaMetrica Pty Ltd | with 0 comments

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