Adviser rejects psychometric risk profiling
Traditional methods of assessing client risk tolerance leave much to be desired, according to an adviser who has developed a different way of doing things.
Thursday, October 11th 2012, 6:00AM 
9 Comments
by Niko Kloeten
While many advisers now use psychometric testing to assess client attitudes to risk, Mike Newton of Newton Ross said he wasn’t convinced of the usefulness of such tools.
“The bottom line is we don’t I guess give a client quizzes or a questionnaire to determine their risk profile,” he said.
“In a way that’s kind of lazy, because you don’t have to do any forecasting work around the portfolio or the different outcomes.”
Rather than using tests to work out how conservative or aggressive clients are with regards to investments and using that information to design a portfolio, Newton Ross approaches the issue from the other end.
“The way we do it is we actually sit down with the client and show them the likely range of outcomes from different strategies in terms of their wealth,” Newton said.
“This requires three things. The first is to understand the expected average rates of return and range of return for different asset classes. Secondly you need to construct a portfolio and understand the risks of this portfolio in terms of the expected range of returns.
“Thirdly you need to model the client’s cashflow situation – the likely cashflow in and out of the portfolio – and given average rates of return work out what is the expected outcome of that portfolio.”
Newton said the process “empowers” clients as it enables them to see the range of outcomes and make an informed decision about their portfolio.
“With risk profiling the question is, what’s right?” he said. “Right is what can only be right in terms of the client understands the consequences of the decisions they are making.
“We get clients who have talked to other advisers who will want to debate the semantics of whether they are conservative or moderately conservative. The question is what the hell do those actually mean?”
Niko Kloeten can be contacted at niko@goodreturns.co.nz
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Comments from our readers
Well said that chap. I think many advisers in the industry would agree with your comments 100 percent. The common sense approach that has traditionally been our role is now continually hi-jacked nowadays by people with a self-serving agenda to push. Advisers are well and truly over it. These so called "experts" need to remember that those that can do, those that can't teach (or should that be preach?)
Example, some years back, a person wanted to purchase a savings plan. After I identified her objectives and time horizon, I asked her about her tolerance to risks and expected ROI over the period. She wanted (almost insisted) a managed funds that is guaranteed and pays above bank interest rates. I said to her there is no fund that will do that. Then told her she is not ready for investment and that she is better off saving in the bank, and walk away. That saved all my time, paper and ink.
Some of you may say, if I should have educated her about managed funds / investments, etc. That is correct, but my gut feel about this client is that should the fund take a dive, her mind will be on her losses and who to complain to rather than the education bit. The thousand plus commission, I feel, is just not worth it. This will save work for the compliance / complaints vultures.
The problem has been, and may be for another generation, the lack of financial literacy in New Zealand and the distrust the public has for our profession, much of the latter because of sharks in the industry, both advisers and providers. The new regime, though welcome, will not help us initially because, we are having to cover our backs all the time rather than making advice a natural process.
Compliance costs will increase and whatever the FMA says, they will have to justify their existence. I personally think they will force some of the good guys out of the industry as well as the cowboys.
For this reason, I choose to be an RFA. I'm in business to serve my clients and to make a living, NOT to feed someone who don't know how to run a business to tell me how to do my business. And, of course, I am anticipating that if not enough advisers become AFAs to feed these folks, RFAs will soon end up also having to pay some kind of fees to make up the shortfall, thus, I have already planned my exit strategy as I am not a fan of feeding vultures.
Don't get me wrong, I am all for regulations, but there is definitely a more effective way which will cost advisers far lesser. It will never be adopted, 'cos the current system has become a gravy train.
I know that the night will follow day, but not sure I could prove it.
Has anyone else noticed that the penalties for doing it the wrong way seem to be far greater than the penalties for actually causing a loss, even if the process is followed?
You said "I know that the night will follow day", while some said "there's light at the end of the tunnel". I say, make that light you see at the end of the tunnel is not the train coming.
Good Luck.
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