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A recently issued survey by the global investing giant BlackRock found surprisingly high levels of doubt about investing, particularly in stocks. (Federico Caputo/Getty Images/iStockphoto)
A recently issued survey by the global investing giant BlackRock found surprisingly high levels of doubt about investing, particularly in stocks. (Federico Caputo/Getty Images/iStockphoto)

ROB CARRICK

Why your adviser may not understand how much risk you can stand Add to ...

Let’s float a theory on why there are so many nervous investors: It’s because the investment industry does such a poor job of talking about the risk of losing money.

When you first sit down with an adviser, broker or financial planner, you’re very likely to be handed a questionnaire to assess your comfort with risk. A study commissioned by the Ontario Securities Commission’s investor advisory panel has found these questionnaires are mostly junk.

Eighty-three per cent of the risk questionnaires looked at in the study were judged inadequate for reasons that include too few questions, or questions that are poorly worded or confusing. Another notable glitch is that 55 per cent of these questionnaires had no way to recognize risk-averse clients that should hold only cash.

We know investors are anxious thanks to a recently issued survey by the global investing giant BlackRock. It found surprisingly high levels of doubt about investing, particularly in stocks, and it showed that people are holding a lot of their wealth in safe but slow-growing cash.

Those lame risk questionnaires feed this nervousness by turning the discussion of risk into a perfunctory exercise in filling out a form. Investors might be more comfortable with risk if they had a chance to have a longer, more thorough conversation about it.

The study for the OSC investor advisory panel makes it clear that regulators have to do more to guide advisers on how to assess risk, and that advisers need to be more diligent about the process. Investors, you also need to act. Demand more from your adviser than a half-baked risk questionnaire.

The problem with today’s risk assessment tools is that they’re too often treated as part of the process of selling investments, said Shawn Brayman, who led the study as president and CEO of the financial software development firm PlanPlus Inc. “These questionnaires haven’t been approached as a professional instrument to measure something,” he said.

Typical risk questionnaires ask for basics like your age, your level of investment knowledge and the number of years until you expect to need the money. Usually, there’s a question that asks if you’re more comfortable with a low-growth, low-return portfolio, or variations that have more potential up and downside. Taken as a whole, the investor advisory panel study found these questionnaires fail on a number of counts. If it’s not flawed questions, it’s arbitrary scoring models.

A total of 338 advisers participated in the study. A little more than 46 per cent said risk questionnaires were optional, and a little more than half said there is no oversight of questionnaires once completed. Of the 43 investment firms involved in the survey (including banks, credit unions, brokers, mutual fund dealers and financial planners), only 19 per cent said they used outside experts to produce their questionnaire, and less than 10 per cent were aware if the methodology used in their questionnaires had been validated in some way.

Whether through questionnaires or a thorough interview process, good advisers learn enough about their clients’ risk tolerance to recommend suitable investments. But there are enough bad outcomes to demand that the risk assessment process be improved. The study quotes the Ombudsman for Banking Services and Investing as saying that investment suitability has been the No. 1 area of complaint from consumers in recent years.

“What’s at the heart of suitability? It’s risk profiling,” said Connie Craddock, a current member and former chair of the OSC investor advisory panel. “There’s often a misunderstanding or a disagreement, whatever you want to call it, between the adviser and the client, and risk is at the heart of that.”

Harold Geller, an Ottawa lawyer who is on the OSC investor advisory panel, says suitability issues are behind the vast majority of the 1,500 or so investor complaints against advisers that he’s been involved with over the years. He says investors feel losses more intensely than gains, and that suggests focusing in particular on the down side. “How much are you prepared to lose is a question I never hear advisers asking. But if you’re looking at risk and reward, you have to consider it.”

If you’re an investor looking ahead to a year-end meeting with your adviser, put the matter of investment risk on the agenda. Discuss how much you’re comfortable losing and over what time horizon. Stock market losses in any one year become a non-issue if you can hang on for 10 years, but shorter periods are problematic. As of late November, the S&P/TSX composite index was just marginally ahead of where it was five years ago and below the level reached before it crashed in fall 2008.

In the investment advice business, risk is a many-faceted word. An investor’s risk profile results from a look at factors like risk tolerance, which is the investor’s willingness to take on risk, and risk need, which means the amount of risk needed to accomplish the investor’s financial goals. There’s also risk capacity, or the financial ability of a client to tolerate a potential financial loss.

With all these nuances, risk is best addressed as part of a broader financial planning process that looks at clients’ current financial situation, their goals and the investment returns required to bridge any gap that exists.

These conversations aren’t easy for advisers or clients. Advisers sometimes need to tell clients they should avoid the riskier investments that pay the highest commissions and fees. Investors sometimes have to be talked out of any notions that they have about making 8 per cent a year with little or no risk, or that they can compensate for weak retirement saving by putting more money in the stock market.

Better risk questionnaires would mean better conversations about risk and, potentially, less anxious investors. “These questionnaires shouldn’t be a marketing piece to shove a client into a portfolio,” PlanPlus’s Mr. Brayman said.

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Talking With Your Adviser About Risk

A recent study commissioned by the Ontario Securities Commission Investor Advisory Panel questions the usefulness of the risk questionnaires that investment advisers use as part of the process of understanding their clients' needs. Here are some samples from a questionnaire that more effectively gets investors to think about risk. It was produced by the Mutual Fund Dealers Association of Canada to provide guidance to advisers who are going through a know-your-client exercise with a client. The full MFDA questionnaire uses a scoring system to assess the client's answers. If you find that the questions presented here get you thinking about risk in a new way, take this page to your adviser and start a discussion.

Investing Objectives

What is your primary goal for this portfolio:

  • i) I want to keep the money I have invested safe from short-term losses or readily available for short-term needs.
  • ii) I want to generate a steady stream of income from my investments and I am less concerned about growing the value of my investments.
  • iii) I want to generate some income with some opportunity for the investments to grow in value.
  • iv) I want to generate long-term growth from my investments.

Risk Capacity

Your current and future income sources are:

  • i) Stable
  • ii) Somewhat stable
  • iii) Unstable

How would you classify your overall financial situation?

  •  i) No savings and significant debt
  • ii) Little savings and a fair amount of debt
  • iii) Some savings and some debt
  • iv) Some savings and little or no debt
  • v) Significant savings and little or no debt

Risk Attitude

In making financial decisions, you are:

  • i) Very conservative and try to minimize risk and avoid the possibility of any loss
  • ii) Conservative but willing to accept a small amount of risk
  • iii) Willing to accept a moderate level of risk and tolerate losses to achieve potentially higher returns
  • iv) Aggressive and typically take on significant risk and are willing to tolerate large losses for the potential of achieving higher returns

The value of an investment portfolio will generally go up and down over time. Assuming that you have invested $10,000, how much of a decline in your investment portfolio could you tolerate in a 12-month period?

  • i) I could not tolerate any loss
  • ii) -$300 (-3%)
  • iii) -$1,000 (-10%)
  • iv) -$2,000 (-20%)
  • v) More than -$2,000 (more than 20 per cent)

When you are faced with a major financial decision, are you more concerned about the possible losses or the possible gains?

  • i) Always the possible losses
  • ii) Usually the possible losses
  • iii) Usually the possible gains
  • iv) Always the possible gains

From September 2008 through November 2008, North American stock markets lost over 30 per cent. If you currently owned an investment that lost over 30 per cent in three months you would:

  •  i) Sell all of the remaining investment to avoid further losses
  • ii) Sell a portion of the remaining investment to protect some of your capital
  • iii) Hold onto the investment and not sell any of the investment in the hopes of higher future returns
  • iv) Buy more of the investment now that prices are lower

Source: Mutual Fund Dealers Association of Canada

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Follow on Twitter: @rcarrick

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