How many times have you been asked whether you have a high, medium or low risk tolerance? Perhaps the question has been phrased differently, testing if you are an aggressive, moderate or conservative investor? You might even have had your attitude to risk assessed and been graded on a scale with as few as three levels and as many as ten or even one hundred. Do any of these statements mean anything (useful) to you?
There is, to my mind, a way to position investment products/services to increase their relevance and usefulness, to the mass-market in particular:
- How about framing the desired outcome, also referred to as the objective, in relevant terms? For example, a pension product/service might have the desired outcome specified as a particular level of income per annum from a specified point in time; and
- Once this reference point has been clearly identified, how about defining a tolerable shortfall relative to this desired outcome as a meaningful measure of the saver’s risk tolerance? The risk the saver is concerned about is not achieving the desired outcome, for whatever reason(s). Returning to the pension example, if the desired outcome is an income of £15,000 p.a., a ‘low risk’ saver might set the shortfall at £1,000 p.a. (i.e. a minimum pension of £14,000 p.a.), a ‘medium risk’ saver might be able to live with a shortfall of £3,000 p.a. and a ‘high risk’ saver might be comfortable with a shortfall of £7,500 p.a. – the distinctions are clear and unambiguous.
Establishing clear and relevant parameters helps savers better align their expectations with the product/service they are buying. Savers can set out to target specific life goals, the availability of suitable products/services permitting, more clearly than is currently the case. When last did investing £7,000 in a diversified growth fund give you confidence that you would be able to go on that dream vacation costing £10,000 in eight years’ time? Perhaps the multi-strategy alternatives fund, with a dynamic capital protection floor was a better fit for this goal? Or not. Similarly, clearly expressing the maximum acceptable shortfall relative to the goal captures the saver’s risk tolerance in a meaningful and intelligible way. The trip might still go ahead if the accumulated savings only reach £9,500 but £9,000 might be the limit before the vacation turns into a staycation.
The Financial Conduct Authority’s Treating Customers Fairly regime expects that “consumers are provided with products that perform as firms have led them to expect” (Outcome 5). Do you know what to expect from a high, medium or low risk product? It would be helpful to understand, to me at least, what risks are being considered, how the aggregate risk is defined and then calibrated. Would we all not be better off having a clear idea of what we were buying/selling rather than dealing with vague terms of questionable relevance?