We Should Ban Risk Profilers: Prove Me Wrong

Risk profiling has become a cornerstone of modern investing, if not an industry in its own right but is it really serving investors' best interests? I argue that risk profilers should be banned. Here's why: 

The Illusion of Precision 

Risk profilers often give the illusion of precision, categorising investors into neat boxes based on their risk tolerance. However, human emotions and market conditions are far too complex to be accurately captured by a questionnaire. This false sense of security can lead to misguided investment decisions. 

Encouraging Overconfidence 

By providing a risk profile, investors may become overconfident in their ability to handle market volatility. This overconfidence can result in taking on more risk than they can truly afford, leading to significant losses during market downturns, particularly if panicked investors opt to move to cash.

Limiting Personal Growth 

Risk profiling can limit an investor's personal growth and learning. By sticking to a predefined risk category, investors may miss out on opportunities to expand their knowledge and experience in different investment strategies. 

A One-Size-Fits-All Approach 

Investors are unique, with varying goals, financial situations, and risk tolerances. Risk profilers often use a one-size-fits-all approach, failing to account for the nuances of individual circumstances. This can result in suboptimal investment strategies that don't align with an investor's true needs. 

The Alternative: Personalized Advice 

Instead of relying on risk profilers, investors should seek personalised advice from financial advisoes who can take a holistic view of their situation. This approach allows for more tailored investment strategies that can adapt to changing circumstances and goals. 

The Case for Risk Profilers 

While I argue for banning risk profilers, it's important to acknowledge that they can provide a useful weather vane or even a helpful framework for future discussions. Professional financial planners should begin with the end in mind – how big is the "pot" a client needs to fulfil their objectives? With the available (and projected) resources, what return do they actually require, and therefore, what is the optimum portfolio most likely capable of delivering that?

 The characteristics of that portfolio (including volatility) should then be explained to a client with clear examples, using visuals mapping across to actual historical events that occurred in the client's lifetime or events they would be familiar with.

Real-Life Experiences 

I've seen many clients who have indicated via a risk profiler that they would be comfortable with a portfolio fall of 10 or 20%, only for those same clients to have tears in their eyes when their portfolio is worth 5% less than the year before. This discrepancy highlights the emotional impact of real-world losses and the limitations of risk profiling. 

The Importance of Conversations and Education 

There is no substitute for well-rounded conversations, education, and ensuring the client has enough cash at hand to meet short (or medium) term needs. These elements are crucial for helping clients understand their investments and make informed decisions. 

The Biggest Risk

Surely, the biggest risk is the risk of not achieving the objectives a client has set for themselves or their family. This fundamental goal should always be at the forefront of any investment strategy. 

Conclusion

Risk profilers may seem like a convenient tool, but they can do more harm than good. It's time to rethink their role in investing and focus on personalised advice that truly serves investors' best interests.

Prove me wrong.