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Why Your Adviser Might Need Help

Assessing another person's risk tolerance is not easy.

The difficulty in assessing risk tolerance is a specific example of the general difficulties humans have in assessing the psychological attributes of others. Many studies have shown our weaknesses in this area, whether it be doctors with patients, teachers with students, managers with staff, or even parents with children, or spouses with one another ... and, not surprisingly given the other studies, financial advisers with clients.

Expert opinion is that such attributes are best assessed using
a psychometric test as input to an informed discussion.

The FinaMetrica test is designed to be used in this manner. However, as yet, only a small segment of advisers are using such a process. The financial advising industry does understand financial risk and can measure it. Unfortunately, though, the industry has so far failed to recognise that testing a psychological attribute such as risk tolerance requires a special set of skills and disciplines - the skills and disciplines of psychometrics.

Psychometric skills and disciplines are not usually found in
financial services professionals or finance academics.

As a consequence, the vast majority of advisers use processes that that have no scientific rigour*. It can be demonstrated that, in theory, these processes should not work and there are research studies which demonstrate that, in practice, they do not work.

For example, during the development trials for the FinaMetrica system, as a control to test for sample-bias, advisers were asked to estimate in advance the risk tolerance of clients who were invited to take the test. These same clients were also asked to estimate their own risk tolerance in advance. Both sets of estimates were then compared to actual test results**.

Clients' self-estimates were shown to be reasonably, though not highly, accurate. Advisers estimates were shown to be quite inaccurate. In one-in-six cases, advisers had made gross errors. In fact, the advisers would have been more accurate if they had simply assumed that all clients were average ... and these were experienced advisers dealing with established clients.

Clearly, much accuracy was being lost in the processes by which the
advisers sought to understand their clients' risk tolerance.

As a corollary, advisers who use FinaMetrica invariably report that when they first use the system with their established clients they uncover some clients where they had significantly misread the client's risk tolerance. If your adviser is a FinaMetrica user, none of the above will be news to them.

There are hundreds of Australian advisers using the FinaMetrica system,
a similar number of US advisers and a small but rapidly growing number of UK advisers.

Your adviser may be one of them. Typically, these advisers are from amongst the innovators and early adopters, and those who actively seek to provide a best practice service. Additionally, the more forward-thinking networks in Australia, New Zealand and the US have adopted the FinaMetrica system for their advising processes.

However, the chances are that your adviser is not a FinaMetrica user.

If you would like us to send your adviser information about how to interpret and use your FinaMetrica risk profile, we tell you how to ask us to do that in the email which confirms your purchase of a FinaMetrica Risk Profile. If you would like your adviser to learn more about the FinaMetrica system, direct them to FinaMetrica's industry portal site, www.riskprofiling.com.

Click here to do your FinaMetrica Risk Profile

* A detailed summing up of the current industry situation with regard to risk tolerance assessment can be found in "Ticking time bombs 1999-2004", Portfolio Construction Journal, Volume One, Issue Two, Spring 2004, written by Geoff Davey, FinaMetrica's CEO. The legal position is set out in "Risk Tolerance Assessment in the Current Legal Environment" by the Argyle Partnership's Peter Bobbin.

View "Ticking Time Bombs"
View Argyle Partnership Legal Opinion

** The study was conducted by organisational psychologists, Chandler & Macleod Consultants. The correlations between clients estimates and test scores, and advisers' estimates and test scores were, respectively, .68 and .38.

View Chandler & Macleod Report