• Failure to meet a desired investment objective, for example repaying a mortgage by a desired date;
• Loss of purchasing power due to inflation;
• Failure to achieve a retirement objective: income level or targeted retirement date;
• Capital depletion by drawing a level of income that cannot be supported;
• Lack of liquidity when there is a need to disinvest;
• Failure of the investment provider or counterparty;
• Lack of diversification, that is, an over-concentration in particular products or funds;
• Under-performance due to overly conservative investment choices.
It follows that the score from a psychometric risk questionnaire does not say anything about which of the above risks most concerns the consumer, or anything directly about his or her personal circumstances.
The key to understanding risk is to understand the reason for investment. Consumers frequently have no real notion of investment risk.
But they are generally clear in their wish not to lose their money. And, perhaps with some help, they can articulate important objectives, such as wanting to have enough for a decent retirement to pay off the mortgage or to fund the education of their children or grandchildren.
Once consumers have stated their objectives, the risks become clear. For example, for a long-term capital accumulation goal, the risk is capital loss on early disinvestment or capital erosion due to inflation.
| Key points |
The most common cause of complaint about an investment is that the outcome has not been what was expected by the consumer. The key to understanding risk is to understand the reason for investment. A risk profile based on a volatility measure communicates nothing about the risks consumers really care about. |
Many of the compensation claims made by consumers arise because their expectations were not set realistically at outset. A risk profile based on a volatility measure communicates nothing about the risks consumers really care about, for example, not being able to repay a mortgage or retire with an adequate income when they want to.
The ability of disappointed and angry consumers to effectively define risk retrospectively, when their objectives are not met, arises directly as a result of a failure to articulate clearly investment objectives at the outset and understand the risks that might result in not achieving them.
Much of the comment on robo advice, as it is unfortunately called, focuses on its limited scope and ability to help close the mass market advice gap.
It might at first sight seem unlikely that it can help the industry do a better job at communicating risk and matching it with appropriate investment solutions. However, although robo advice can never compete with traditionally delivered advice from an experienced professional, two features that, paradoxically, stem from its limitations, point the way ahead.
