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Muralidhar.
How important are risk preferences for DC – Muralidhar 10.30 am Today
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"one of ten websites and blogs every investor should bookmark"- The Times.
This survey really is dubious. It takes no account at all off your current financial situation. To many better off people both options are a complete irrelevance to their overall financial situation. To them such choices are just an irritation to be answered quickly and randomly.
The real risks people face in life are things like:-
Will they get made redundant and if so will they find another job and at what pay.
How long will they live and how long will that life will be healthy.
Will they get married (or have a partner) and how long will they stay married.
Will a partner or somebody else they care for develop serious health conditions.
How will taxes and benefits change over the years.
For many if not most people these are just unknowables.
Richard you are right but we cant leave the cleit with arandom walk.
I think we need to take this at face value and see where this leads. A quick summary (PART 1) and then a practical objective (PART 2) of knowing what Pot size is required to give a desired outcome at a given age.
I have used the objective of 120% of final salary and taken £100,000 of income as final salary at age 78 to make scaling easier. I have used AI to help present the math. I hope the links work.
Summary of Key Risk Propositions
Based on the Muralidhar and Berlik (2017) paper “What’s Your Risk Appetite?” and similar behavioural finance literature, here are the main propositions about risk:
Core Methodology – Quantifying the Value Function
The paper presents a methodology to allow advisors to quantify risk tolerance of clients over gains and losses based on the Kahneman-Tversky survey LinkedIn. Once a formal and quantitative estimate of an individual’s risk appetite can be determined and tracked over time, advisors can design effective investment portfolios tailored to specific client risk tolerance.
Key Risk Concepts
1. Risk Components Risk tolerance combines risk appetite (willingness to take risk) and risk capacity (ability to take risk) Advisor Perspectives. ‘Known risk refers to normal risk that can be comprehended easily and quantified using historical data, while unknown risk occurs once every 10-20 years and falls outside expectations (Advisor Perspectives).
2. Value Function Characteristics The Kahneman-Tversky value function that underlies risk assessment has three critical features:
• It is concave for gains, implying risk aversion ScienceDirect
• It is convex for losses, implying risk seeking ScienceDirect
• It is steeper for losses than for gains, demonstrating loss aversion ScienceDirect
3. Loss Aversion People value losses and gains disproportionately, being more likely to feel worse about losing $100 than to feel better about gaining $100, regardless of absolute wealth The Decision Lab. Losses loom larger than gains, with the observed asymmetry being far too extreme to be explained by income effects or decreasing risk aversion at Fullerton College.
Investment Tribes and Behavioural Diversity
Organisations have “investment tribes” – groups of individuals who exhibit similar risk tendencies for gambles involving gains or losses, SSRN. Quantifying and making transparent the existence of these tribes and individual preferences using the Risktyle methodology could improve decision-making, especially during market crises, ResearchGate.
Practical Implications for Advisors
Risk Profiling Requirements Risk profiling is a process that financial advisors use to determine the optimal level of investment risk for clients, and since risk profiles are not stable over time, they should be updated every few years. Neuroprofiler.
Behavioural Coaching Value The value of behavioural coaching ranges from 0.6% to 2.5%, with higher behavioural risk leading to higher value from coaching Andes Risk.
Addressing Biases Financial advisors should educate clients about biases inherent in decision-making processes and emphasise the importance of diversification, disciplined investment strategies, and long-term thinking to counteract biases such as herding behaviour, disposition effect, and overconfidence. ResearchGate.
Probability Weighting
The weighting function overweights low probabilities and underweights high probabilities, leading individuals to overweight the tails of any distribution – meaning they overweight unlikely extreme outcomes NBER.
These propositions collectively suggest that effective financial advice requires moving beyond traditional rational-utility models to account for documented behavioural biases and individual differences in risk perception and tolerance.
PART 2
Retirement Capital Requirements
TARGET ANNUAL INCOME
€120,000
Inflation-adjusted
REQUIRED CAPITAL
€2,666,667
At 4.5% withdrawal rate
EXPECTED RETURN
7.5%
Adventurous portfolio
Key Assumptions
Current Annual Income:€100,000
Years to Age 100:22 years
Expected Inflation:2.5% p.a.
Safe Withdrawal Rate:4.5%
Expected Portfolio Return:7.5%
Real Return:5.0%
Important Considerations:
• This calculation uses a 4.5% safe withdrawal rate based on updated Bengen research for a 22-year horizon
• The portfolio is designed for an “adventurous” risk profile with 85% growth assets
• Annual income adjusts with inflation to maintain purchasing power
• Actual returns will vary year-to-year; this shows expected long-term average
Adventurous Portfolio Design
Global Equities (Developed Markets)70%
US, Europe, Japan large-cap stocks – Core growth engine
Emerging Markets Equities10%
China, India, Brazil – Higher growth potential
High-Quality Bonds10%
Government & investment-grade corporate – Stability & income
Inflation-Linked Bonds (TIPS)5%
Direct inflation protection for income stability
Alternative Investments5%
Infrastructure, commodities, gold – Diversification
Portfolio Characteristics
• •Risk Level: Adventurous (85% growth assets)
• •Expected Return: 7-8% nominal, 4.5-5.5% real
• •Expected Volatility: 12-15% annual standard deviation
• •Rebalancing: Quarterly or when drift exceeds 5%
Strategic Rationale (2026)
• •International diversification reduces US concentration risk
• •Emerging markets offer attractive valuations and growth
• •TIPS provide direct inflation protection for income needs
• •Alternatives improve diversification in volatile markets
Implementation Recommendations
Suggested ETFs/Funds:
• MSCI World Index ETF (60-70%)
• MSCI Emerging Markets ETF (10%)
• European Government Bond ETF (5-7%)
• Euro-denominated TIPS or Inflation-Linked Bonds (5%)
• Infrastructure/Commodity Fund (3-5%)
• Gold ETF (2%)
Risk Management:
• Review portfolio quarterly
• Be prepared to reduce spending 10% if market drops sharply early
• Maintain 1-2 years expenses in stable assets
• Consider tax-efficient withdrawal strategies
• Review allocation every 3-5 years as you age
The FCA has published (14/11/2025) the findings from a multi-firm review focused on firms’ business-wide risk assessment (BWRA) and customer risk assessment (CRA) processes. The key findings relate to the following topics:
https://www.fca.org.uk/publications/good-and-poor-practice/risk-assessment-processes-and-controls-firms-our-findings?utm_source=regzone-daily&utm_medium=email&utm_campaign=RegZone%20Daily%20Campaign%202025-11-11%2018:30:02&utm_id=6153&utm_term=engagement
Identifying, understanding and assessing risk. Most firms have a BWRA but few are identifying relevant risks and tailoring the BWRA to their specific business.
Some firms can show how risk appetite, BWRA and CRA processes work together to identify and assess risk. However, the FCA is concerned that other firms could not sufficiently explain how they are managing and mitigating identified risks.
Mitigating risk. Financial crime risk is often considered in business strategy, growth and product development.
However, there is little evidence of how risk assessments, decision-making and monitoring activities are joined up. Some firms have a clear risk appetite that is closely linked to the BWRA but very few have documented actions resulting from their risk assessments.
Managing risk. Many firms recognise the importance of appropriate governance and oversight to ensure risk awareness and thorough risk assessments. However, senior management appear to better understand and be more aware of fraud risk than other financial crime risks. Some firms carry out limited or no testing and reviews of risk assessment processes when they make enhancements, upgrades or implement automation.
The FCA expects that firms are already complying with existing requirements. Where weaknesses were identified during the review, the FCA is working with those firms to make improvements. Firms are encouraged to consider the findings and continue reviewing their risk-based approach to financial crime systems and controls