As referred to in our previous article “The 5 Step Financial Planning Process” a client’s risk assessment is completed at the very early stages of the process. It will dictate the clients risk rating and ultimately the investment strategy pursued with the objective of achieving the client’s financial goals.

Sophisticated risk assessment has many benefits and this article will concentrate on the most important benefits for client and financial adviser alike.

Risk assessment explained
The financial planning risk assessment is measured under three headings:

1. Attitude to risk:
This measures the clients understanding of the concept of risk and how it applies to their life and financial matters.

2. Tolerance for risk:
This seeks to explore how much volatility a client is prepared to absorb and observe over the lifetime of an investment based on past experience and future expectation.

3. Capacity for risk
This quantifies the clients’ ability to absorb a loss or their rate of change in financial circumstance if a large gain or loss was the outcome of an investment.

Deloitte Pensions & Investments assess the risk rating of a client using a detailed psychometric risk-tolerance test and proprietary software developed by risk assessment experts FinaMetrica.

The client completes a risk questionnaire and entering the answers to the risk profiling tool produces a score of between 1 and 100 placing the client into a risk category of 1 to 7.

Benefits to a client of risk assessment
A client that has been through a thorough and comprehensive risk assessment will experience a number of important benefits.

• The process will develop a risk profile for a client and they will be risk rated and placed into a category of 1 to 7. This will in turn dictate the clients’ asset allocation and investment strategy and ensure the level of risk and hence return in a client’s portfolio is appropriate relative to their risk appetite and capacity. This will be one of the greatest determinants of a client’s financial planning experience and it is crucial that the approach is thorough and scientific 
• Risk assessment has the added benefit for a client in raising their confidence in the relationship with the adviser as it demonstrates that the adviser understands the need for comprehensive risk assessment and through the employment of a risk profiling tool has taken a scientific approach to this topic. The adviser will not merely rely on their view of a client’s risk rating but seeks to have it quantified on an identifiable scale.
• Increased awareness and knowledge of the clients’ risk attitude, tolerance and capacity for risk will aid the client is making any future financial decisions. It provides a level of comfort that they now have an understanding of how their risk rating is measured and can use this knowledge when making decisions that affect their finances going forward.

Benefits to a financial adviser of client risk assessment
Financial advisers employ a comprehensive risk assessment process as they are obliged to by the Central Bank of Ireland and there are also other tangible benefits for the adviser.

• A psychometric risk-tolerance test will produce a detailed picture of a clients’ risk rating allowing for the development of appropriate investment and product strategies and ensuring an optimum level of investment risk or contained in the portfolio. A clearer relationship between the client’s goals and risk appetite will emerge and assist in the investment process.
• Detailed risk assessment builds trust and develops the relationship with the client. Understanding a client’s attitude to risk provides the adviser with the evidence needed to develop a proper financial plan and having a measurable risk rating give credence to the investment strategy the adviser will produce.
• The final benefit of risk assessment covers both client and adviser though it is most relevant to the adviser as in the event of a dispute at a future date it will provide documented evidence of the risk-tolerance test employed. It can also prevent future uncertainty on behalf of the client if an unexpected event occurs over the course of a client’s investment and financial life time plan.  

Conclusion
Risk assessment is a crucial component of any financial planning process. A properly defined and documented process will give the greatest chance of a successful outcome. It will not guarantee the removal of any future issues but will provide comfort for both client and adviser that a sophisticated and scientific process has been employed.

Deloitte Pensions & Investments is authorised to provide investment and financial planning advice and is regulated by the Central Bank of Ireland.

Enda McGuinness is a CERTIFIED FINANCIAL PLANNER™

Contact

Enda McGuinness
Pensions and investments
emcguinness@deloitte.ie
+353 1 417 8557