Behavioural Investing Series #4 – Transcript

Fraser Jack
Hello, and welcome to this topic series on behavioral investing, where we take a deep dive into the client and advisor decision making process. My name is Fraser jack, and in this episode number four or five, we cover risk profiling and advisor investment philosophy, where we can start and where we should stop. So if you want to do more than just what’s compliant, when it comes to getting to know your clients in this episode is a must. Welcome back everybody. In this particular episode of the series, we are focusing now on risk profiling and understanding the different aspects around risk profiling, we sort of look back into the past and think about the ways that it was done and why it was done. Obviously, it came out of a conversation around no your client. But you know, we’ve just talked about goals based investing. We’ve just talked about biases when we’ve just talked about values based investing. And, you know, it’s often been very difficult to see how risk profiling in the past has related to those things. I think I think we’re all sort of changing along the way. Welcome back to the conversation, Patricia and Catherine, I’m going to start with you today, Katherine, on this particular episode on risk profiling, because I’ve know you’ve done so much work in this area, tell us about the work you’ve done.

Dr. Katherine Hunt
I love the topic of risk profiling. Because as as you’ve you know, you’ve seen how many, maybe 20 fac fines from different licensees over the years. And they all have this the same more or less same set of questions. And so I started thinking, I wonder where those questions came from? Where did they come from? I still don’t know. But they definitely did not come from the academic literature. It’s like, someone just invented them at one point. And then everyone just was like, well, it’s used by someone, so can’t be that bad. And it is bad, probably. So we can test

Fraser Jack
my theory on this. I think they’re actually invented by distribution of funds that needed to be sold as a, you know, a tool or a product. So we ended up with, you know, back in the day, if it came out. Back in 2001. We had all these, you know, fund managers, they had five different products and we and we had to fit humans into one of their five, but are they balanced that they’re high growth? Are they are they you know, are they conservative? And I think we managed to turn three into five and thought that was amazing. But I think we’ve moved on from there, Katherine, keep keep going.

Dr. Katherine Hunt
We absolutely moved on, we have some baby steps, baby steps. There’s a huge body of literature these days at least. So there’s these personal finance academics who research this stuff very heavily. And they do kind of niche areas. And I’m I take a more strategic approach, because I’m interested in how it’s actually applied to determining your client’s risk tolerance for the purpose of financial advice rather than what the academics do, which is just let’s figure this out for no reason other than we want to. So I see it has those three components, risk capacity, which is comprised of human capital and financial capital, risk tolerance, which is the psychological side. So their particular present bias loss aversion, and there are academic ways of assessing that available as well. And the third one is the risk need, how much risk do they actually need to take for this particular goal, which is a complicated discussion in itself, but they all kind of form a part of what becomes the overall risk profile of the client, and they all are important contributors to their risk profile.

Fraser Jack
They kind of feel to me almost like they’re all involved in the prioritization of the goals as well.

Dr. Katherine Hunt
That could be true, that absolutely could be true, especially if you take into account risk capacity, for example. We generally know where it’s moving So, within risk capacity you we have human capital, which is our ability to earn income over our lifetimes. And so that decreases as we age, because our number of years available to work decreases as we age. Whereas, on the other hand, financial capital generally increases as we age. But it’s something that as financial advisors, we know exactly what not exactly, obviously, but you know, we know the ballpark of where it will be in the future. So it’s kind of quantifiable, which means we know at which point of a person’s life, which levels of risk should be taken based on their levels of risk, their capacity to take that risk, quantitatively speaking.

Fraser Jack
Now, Kevin O’Leary, I’m gonna go into these individually in a minute. But before we do that, I’m gonna want to hear from Patricia. But, but as you speak, I also think about the Agile world and the tech world and all those sorts of things. And there’s a thing called de DVF, desirability fees, viability, and then feasibility are all different concepts of ways of prioritizing. So yeah, it’s an interesting idea around how we prioritize goals. But Patricia from from a practical point of view, obviously, when you’re when you’re an advisor, you get handed down, you know, from licensees, all the time, this idea of risk profiling, and then you sort of just got to work out from a business point of view, how to expand on that and make it make it an opportunity to find out more about your client. How do you go about this?

Patricia Garcia
Yeah, and I definitely, risk profiling is not my favorite subject in the sense of a different from a different angle, they will Katherine came from in the sense that they’ve always, you know, traditionally been pretty useless. So I think, you know, that’s why houses advisors have had to use a lot of other tools to help with that. And the risk profiling tool just became more of a compliance take at the end, to make sure that our licensee is happy. But we have to use a lot of other tools and education to get to that before we even complete the risk profile. And that’s how I do it, because I still don’t think that there is a perfect, you know, risk profiling tool out there. I think risk profiling in its in its own form isn’t a black and white process, either, you know, that there is a lot of gray that requires us to, to our head offers advisors to get to the bottom of with clients. So the way that I approach it is on the educational side of things. A lot of the times is talking about the different ways to invest, giving clients you know, Crash Course, into the fundamentals, the risks, but then using our professional judgment as to overlay that, and it does get a very great or the need to take risk. And I talk to clients about that a lot of the times, and a lot of the times he might have fairly wealthy clients don’t need to take risk. But then on the other hand, they can afford to take risk. So why wouldn’t they continue to grow their wealth if they can still afford to. So it is a very, I think, very difficult. Cause not not conversation, but a difficult subject, because there is a right or like right or wrong, in my opinion. And even the different ways of risk profiling. It’s not nothing is actually right or wrong. It’s at that particular point in time for that particular purpose for that particular goal for their particular situation in the mood that I’m in today. I feel like this. So I think, you know, our job is to, I think try to avoid the red flags and try to focus on the potentially bad decisions that they could be making. So you know, there’s got to be a middle ground, there can be there can be, it can be good, you can deviate up and down. But we want to make sure that if they’re making a bad decision, there is a red flag or a few things that they haven’t considered that we’re bringing that to their attention, were really explaining the consequences. That’s probably how I feel about it. Because that the same accord you may not need to take the risk and you know, is it our job to then recommend is really conservative, you know, put it all in cash and you know, you don’t need but that that’s not in their best interest. So I think the clients have to help us decide what’s in their best interest. And our job is to give them the tools to to get to that

Fraser Jack
position. Yeah, there’s definitely a lot to do with the concept of taking this as an opportunity of providing them with more financial literacy and teaching them and then and then in return, you know, getting that understanding back and that informed consent back that they are informed and understand what they’re talking about. Katherine I want to dive into these particular areas capacity tolerance and need in a little bit more depth as we go through so that we can open up the box and explain them a little bit in a bit more detail. But that we would risk capacity, how do you describe that

Dr. Katherine Hunt
risk capacity, as the name suggests, is our capacity to take risk. And it’s a quantitative measure. So it’s, it’s not fluffy, like the risk tolerance. It’s, it’s black and white to some extent. So we have human capital, which decreases as we age, in general, and we can calculate people’s human capital. So the number of years of, of higher education that you have the level within an organization, so whether you’re entry level, etc. And the trajectory of that, so whether you been gone up a level, so to speak in the previous five years. So of course, years of experience, increases human capital, even though your age must decrease your human capital, because you no matter, the highest level of you might be at the peak of your career. But if you’re 65 years old, and you want to retire at age 67, then your human capital is much lower, much lower than someone who’s fresh out of university and entry level. So the human capital component is quantitative also.

Fraser Jack
Yep. And so that we can crunch those numbers. And obviously, the financial capital, probably the easiest one that most people look at, we probably don’t need to go into that in too much depth. Because we know we understand that there’s income, there’s expenses, there’s cash flow, there’s, there’s existing, you know, assets, all these things are fairly, fairly standard. Let’s dive into the tolerance piece of it, because there’s obviously different pieces of this interesting jigsaw puzzle.

Dr. Katherine Hunt
Indeed, indeed, there are. And also, both risk capacity and risk tolerance, really do have that angle of supporting the rich get richer, and the poor, get the picture. Because both of them are setting people up in a way. And this is a systematic issue with even the best scenario, which is the one that I use for risk profiling, setting people up in a way, if they don’t have the resources available, if they don’t have the tolerance for the risk, then they shouldn’t. And then they shouldn’t invest in accordance with, say, their long term goals. And of course, who do we know has low risk tolerance, it’s single mothers. That’s it. And it makes sense because they’re the people who are, they’ve got the most on the line, I suppose, with providing for their families and whatnot. And there’s a huge amount of data on this, we’re not talking about the Australian context, here we’re talking about, there’s a huge amount of research on this on risk tolerance across the world. So that’s what the data says in general. And so the actual component of our psychological tolerance for risk, we can call it our aversion to loss, which is an individual tendency. So some of us are easy come, easy go, no problem. And some of us are, oh, my gosh, I lost $2 Out of my fell out of my wallet, I’m going to go on prowl the streets for three hours and look forward. And we’re just different in that way. We do have a little bit of fluctuation, based on the day. So if we’re hungry, or if we’ve been primed with something, if the media has been talking a lot about some crazy statistics all the time, we can be primed, and we can so we can be less risk tolerant. But by and large, we do have consistent risk tolerance across our lives across our lives. And so we can calculate this also very qualitatively. So part of the test is about present bias. So whether people really are focused on the now and not taking any risks for the future, because they don’t explain the future doesn’t exist to people who are very present biased in the extreme. And that’s the question of do you want $50 Today, or $80? Tomorrow, you choose those tomorrow, $50 Today, or $80 in a month, most people’s still choose $80 in a month. But when it moves on to $50, today, or $80 in a year, even in a theoretical sense, most people will move towards the $50 choice even though the that’s a pretty big return for sticking it out for a year, quantitatively speaking. So that shows us people’s level of present bias. And the other way that we quantitatively assess this, this particular tolerance for risk is we use a gambling game, and the best way is to use kind of real money. So even if we have a small amount of money available to do this, and we say you have $10 to gamble on these experiments, one of your answers will be randomly chosen, and you’ll have the opportunity to actually win that gamble that you’ve chosen and the gamble will be would you prefer to 10% chance of winning $100 or 1% chance of winning $1,000. And so there’s all of these different possible Gamble’s, and they just choose the 10%, or the 1%, or the 50%, or the 10%. So there’s different percentages and different amounts that they can win. And by putting in putting it, they don’t put it in, they are given, of course, the $10. But then I think that it’s an I know, it’s their money, and they have the actual chance of winning this particular money, real money. So then we start to move from the theoretical, which is that oh, no, no, I don’t like taking risk to the practical of this. Is your money on the line here? What will you choose? Because I wonder as Patricia, from your experience, it might be the case that in in the office, in those initial meetings, clients might be saying, you know, we did pretty fine with a 20 30% drop in the portfolio, I don’t think we’d be too fast. And then when the rubber hits the road, it’s the Oh, no, I’m not ready for this at all. So finding out where that the balance between reality, and what exists in their mind, is a really difficult concept with risk tolerance and tolerance for risk. Is that your experience?

Patricia Garcia
Yeah, to an extent, I think we’ve been lucky enough that we have educated class quite well and have had the apps and have had the downs. And a lot of them have experienced Jesse before. So experiences pixel, you know, that that’s, I think, what counts the most is having been there. But I also make sure that I put it into numbers, and I put it into their numbers. So for example, I don’t just ask a 20% question, I say, Hang on, you’ve got 1.5 million. So 20% is, you know, three or $1,000. That also changes the, the exam. And then we go to the process ago that that will happen. Like that actually will happen. I just don’t know when. So what are we going to do about it when it happens? And we will work through that. So I think my experience is more around there. When it does happen. People just change their behavior. So for example, they and this is part of what we tell them that actually we say, you know, what you can do at that time is your control, you can control. So maybe the holiday that you had planned for a year, can you delay that? Maybe you will tighten your belts, maybe you will, yeah, delay your retirement. So we like prompt some of these discussions before they happen so that when he actually happens, they’ve had that before, and it feels familiar. But yeah, it’s all about I think, we just say no, you can’t control, just focus, or you can control remember, we’ve got the backup option is the backup option. And we just, we just keep reminding them over the backup option is and while we were the way that we were. So I think when it happens, in my experience with my clients is more being about they might change a little bit in terms of they’re more conservative, they’ll spend a bit less they will, you know, know what, maybe they want to invest less, rather than more the time when they maybe should be investing more, and then again, we’ll talk about it. So I think because we’re lucky in the way that the relationship that we have for clients is quite strong and long term that those discussions don’t become like a blame on us, or, you know, I didn’t see this coming. So it’s easier to navigate. But it’s it’s not easy, you know, nobody likes to see their portfolio go backwards, even if you remind them that actually no, this is good for you remember, like, well, you know, as they are wealth creators, you know, we buy really cheap shares, for example. So, yeah, I think, again, you know, even with our money, we were not happy with that. And now my financial advisor, and I know, I know, I have to remind myself, none of that that’s a good thing, you know, if I’m, if I’m buying, so I think it’s just a matter of Yeah. Of, again, worrying about what you can control. That’s what I keep reminding them.

Fraser Jack
Patricia, I really love this idea. And Katherine, you mentioned as well, this idea of putting things in their own dollars, and then understanding what that means to to the client. You mentioned the, you know, the, you know, the game or the gamification style of using real money and in that, in that psychological area, that tolerance area, I think it’s important. It’s, it’s actually I’ve heard of one to recently that around the need, you know, but we talked about need and prioritization around, you know, here’s, you know, here’s 100 $100 And, you know, 10 $10 notes, I want you to put the, you know, in the buckets that you wanted to go into what’s more important than the other and you can’t put the same amount of money in, in each bucket, you’ve got to you got to have it as a different level of money. So that that forces people to then prioritize, but, and but then comes back to their own, you know, the psychological effect of them physically going through some sort of a gamification process in this risk tolerance. Area is I think it’s fair really, really a cool thing I want to see more more of that happening. Katherine just will finish up quickly on the, you know, risk need sort of the third area that you mentioned, tell us about all the different moving parts of that.

Dr. Katherine Hunt
So the risk need is another quite quantitative assessment, which is based on what what that goal looks like in terms of how much money is needed, and the timeframe that it’s needed by and basically, which then is result in a reverse calculation of asset allocation for that particular goal. And it’s a it’s an interesting component, because it’s also, you know, it is the client’s goal. So it’s not imposed by us. But at the same time, we’ve calculated what risks they need to take, rather than ask them what risk they’re comfortable with, in this particular component. So it’s, that’s why it’s obviously part of the the analysis or not the entire thing, because there has to be some kind of balance given there. And I’d be really interested to hear what Patricia has to say on how that actually plays out in interplaying, with the rest of the components of risk profiling on a practical level.

Patricia Garcia
Yeah, it’s a really tricky one, right? What you mentioned before Catherine is so true, is the people that need to take risk, are the ones that aren’t naturally comfortable, the people that don’t need to take the risk are the ones that aren’t really comfortable. And so, you know, it is part of what we need to look into, but it’s not everything. So the way I’ve addressed it in the past and example I can give is that is a little bit more complex, is around. So when you do your bucketing strategy, and let’s say it’s for someone that is about to retire in two, three years, so it’s not like they’ve gotten a lot of time to, to, you know, learn and be educated to increase their risk profile over time. You know, like, the simple example is, you know, that single mom that you’re talking about, but she’s young, and it’s her super, maybe you might start more conservative, and then you educate them in a new over time, increase the risk tolerance when they’re more comfortable. And then that could lead to much better outcomes. You know, that’s a simpler example, another one where it can be where sometimes it’s just, you’ve just got, that’s how much he’s got, you know, you’ve only got two, three years to go. And that’s it, you know, you’re not gonna keep working in your 70s. And or you can’t get a job or whatever it may be. And you may even save enough. So in that particular example, what I’ve done is I’ve looked at different levels of spending, and then what the different levels of spending meant from a risk profiling from a pocketing and asset allocation perspective, and then potentially, even though we might implement a more growth, so like, let’s say, for example, they need to have I don’t know, around 70% in growth assets, but I’d say the risk tolerance seems to be more like 50, I’m just faking figures or, or the bucketing approach says it should be 50. Let’s so let’s say that. So the bucketing approach may be calculated to be 50%. But they need to take more like 70% or higher growth, you know, would explain that to them. And then we might do other calculations with lower level of spending. And then depending on which one is much more important to them, you might then go okay, well, if you spend less, you can potentially invest more conservatively. Or if you want to increase the chances of having more, or your money lasts longer. But you’re worried about, you know, the markets running out is at that point when the market does, you know, crash or something significant happens? Can you then reduce your expense? Like, have you thought about events, so you essentially have the different discussions, and he tried to explain that, you know, very, like the solution is not perfect. And these are the risks in each of them. And just give them as much information as you can to help coach them to make that decision, because I don’t think it’s a decision necessarily that we need to make for them. It’s around just again, explaining that we just don’t have the perfect solution, you know, you’ve run out of time, in a way, and these are your options. And these are the risks.

Fraser Jack
Yeah, I feel like from what we talked about here from that from what your points that you’re both bringing up. That is risk profiling traditionally has been done prior to investing. So you do the risk profiling, that’s it, then you find out how much money they get, you know, like all those sorts of things. In the order of the scheme of things. This is risk profiling shouldn’t be done. Just first set and forget, it’s all about saying, here’s where we’re at. Here’s some more information. We go back and we adjust and the risk profile isn’t really set until all the goals conversations have been had. Katherine

Dr. Katherine Hunt
definitely. I love that approach that Patricia Patricia has of that The continued evolution of the client’s risk profile, and those quantitative and psychological components all playing a role. And there’s a couple of interesting things, I think that we can do like as advisors. So I haven’t got the update up to date data. But it’s a few years old back back when there was far as before, that was Africa. 70% of the financial advice claims that went through there were because of, or under the category of risk profiling. And that’s because of course, you can put a claim in or a complaint or whatever it’s called, based on investment returns. So they all went under risk profiling. And if you look at the quality of our risk profiling tools, it does make you be a little bit worried. And I think a really interesting reflective tool, especially for advisors, who have multiple advisors within their offices, would be to just check and see what kind of bias and influence you’re making on your clients. risk profiles that that come out, because we do actually have a bias. And we do influence that whether it’s unconscious or conscious, probably unconscious, obviously, in this scenario. So it’s easy, what’s the risk profile of the advisor, everyone knows their risk profile, usually, as an advisor, and then just take your entire database and find the average risk profile of your clients and see what it is. So there’s a firm I know that did this process, they had about 10 advisors. And nine of the advisors were high risk tolerance individuals, you know, they’re very experienced educated in the space. And on average, their clients had high risk tolerance also. And there was one advisor, who was a young fellow, but he was very conservative, and he didn’t want to take risk for his own investments. And it just turned out that his clients, were also on average, conservative investors. And so this kind of activity, of course, you can easily control for the demographic influences and that kind of thing as well, if you’re really interested in it. But it’s a great thought exercise to help advisors think I wonder if I’m influencing this process, like, first off, it’s a very important process of critical component of our ongoing discussions with the client. And second, I want to how much influence I’m having on the results of what client Restore is actually comes out at? Yeah, I

Fraser Jack
think, absolutely. And we might leave it there, because we sort of touched on that, again, with the the original episode that we did in the series around the biases. Thank you so much, Patricia, thank you so much, Catherine, for this talk about risk profiling. We’ll catch you in the very next episode, when we start getting into modern portfolio theory. And we’re continuing the conversation now about risk profiling. I’m talking to Dan and David, I’m gonna throw to you first, David here. What are your thoughts? Obviously, where there’s, there’s a lot going on in this space, there always has been, it’s been highly criticized, it’s been, you know, it’s been the punching ball for a lot a long time. Tell us about your thoughts and ideas around risk profiling.

David Bell
Yeah, phrase, I agree with everything you’ve just said in the introduction there, it’s, it is a bit of a punching bag of the industry. And, and, and yeah, hopefully, understanding the risk profile of the client is really comes to the forefront, again, of being used in the right way. The worst outcome would be this, this becomes compliance to comply with, you know, what your duties are, in terms of developing that comprehensive plan for your client say, hopefully, that’s not the case. And you start off with your psychometric measures, and they’re sort of an overall, is it based on this concept that you sort of have a risk tolerance characteristic about you, and you’re prepared to apply that risk tolerance to all activities of your life? And that’s sort of a concept that I find quite challenging. You know, I think it mixes with a whole range of things. So it mixes with something I mentioned before, which is ambiguity aversion, which is sort of, you might be prepared to take risks, but you might want to take those risks where you actually understand the risks that you’re taking. So this sort of doesn’t get as much attention as risk aversion itself. I think the two are so interrelated. So if I’d tried to describe myself to you, I’d say I’ve got medium risk tolerance. But I’d say I’m highly ambiguity averse. I really won’t invest my money until I understand the nature of those investments. So that’s a tries to frame it yet. Yeah, that ambiguity doesn’t really exist much. Yeah. In the company go in the guidance that comes out from what is good regulatory practice and safe often the whole range of issues like these say, Yeah, I think let’s not treat it like a compliance exercise, let’s in somehow decrease the formalities that that are around its requirement and try and refresh our use of risk aversion and make it used in a really positive way. So where I’d like to get to

Fraser Jack
Yeah, I agree. I think it started out as a you obviously know your client, and then it became a short questionnaire for either purpose and then those questions became drier. and drier and more practical. Dan, you’ve got some interesting thoughts and ideas and opinions on this, let’s, let’s throw them out there.

Dan Miles
I’ve got some strong opinions on this. And some of them, I’ll pick up on some things that David said. And I know he said, We don’t want it to become a compliance exercise, let’s, let’s be honest, that’s exactly what it’s become, it’s become a box ticking exercise. I haven’t spoken to a, you know, an advisor that I would consider high quality that would go through a risk profile questionnaire, then use whatever is this, they get at the end to make all the decisions for the client, at the end of it, that just they know that that is wrong. And it has become a compliance requirement. And let’s just face it, that’s what it is. It doesn’t have to be it can be it can be far more more valuable. And the idea, David, you said that the concept of risk tolerance applied to everything across your whole life, you find challenging, I would have used much stronger language, I think it’s absolute, just just complete and utter garbage. The idea that you have one single risk tolerance for every aspect of your life, all goals, and everything that occurs and and we’ll be like that forever is just absurd. It doesn’t exist, your risk tolerance will be different, based on your time horizon, based on when it is you want to achieve your goals. And at what point in which you, you know, you want to prioritize those. And then we don’t take into account at all one’s capacity to take on risk, we’re talking about risk tolerance, because you know, whether they can sleep well at night, but what about their capacity to take on risk. And also, potentially, they need to take on risk, because somebody could have, you know, very high risk tolerance, and be prepared to take on massive amounts of risk. And they have huge capacity, because they’re quite wealthy, but there’s absolutely no need, given the goals that it is that they’re trying to achieve. And so, under a traditional framework, you would invest them based on that risk tolerance, applying, you know, inadvertently exposing them to risks that they do not need, which may mean that they don’t achieve the goal that, you know, they already have the capacity to achieve if they’d invested in a completely different way. So I think it needs an entire overhaul and needs to be thought of in a multi dimensional framework, not just you know, different types of risks. So tolerance, capacity knee, you know, the the risk of not achieving a goal, but also intertemporal framework as in over different time horizons, because, you know, depending on your time horizon, you may have a different capacity or need or ability to take on risk. Yeah, sorry, I have very strong opinions about that. And I really think it can be approved

Fraser Jack
a lot. Yes, I think it does have struggled with the concept of, you know, goals based investing, values based decision making all these things that we sort of touched on in the past and then going and opening up their, their standardized risk profile and go, well, this doesn’t match anything, you know, banging their head against the wall. It’s definitely a tricky one. And I think one of the things that they don’t take into account is, is that either decision making behaviors like past decision making behaviors like the what sort of car do you drive? Why do you choose a top of the range or a low, you know, what, whatever you choose to make you know that the previous decisions that you’ve made around money have generally been passed by based on some sort of goal or value? So I sort of don’t really take any of that into account either.

David Bell
Yeah. And yeah, getting back to your word, which we both mentioned, Dan, which was that compliance word and say, You did fall back on a system and it misses all the information that you’ve just sort of talked to Fraser and yeah, but on the other hand, if you say, well, let’s put these systems aside and let advisors this assess a client’s make their own judgment was research that show there’s an advisor effect. So your advisors own degree of risk aversion will actually affect their every assessment of their client base. And you don’t want that happening, either. And so how do we sort of unpack this and make use and I think some of the elements that you guys mentioned, actually, the word that cries out to me is framing if if the goals are framed in the right way, and then you have that sort of risk discussion? Surely, that’s got to be a far more relevant assessment of the risk tolerance or risk aversion of your client then does something that’s generic and not has no context around it? And I think that’s, that’s really where hopefully we can get to, because from a compliance perspective, compliance has to evolve because every risk tolerance assessment will be a unique piece of client interaction is not something that can be systematically compared in the way it has been in the past where you say, yep, this user has a standard ticking the box for this. So yeah, there’s a real uplift opportunity. And I think it’s a it’s a really positive one for the industry.

Fraser Jack
Yes. As somehow we’re going to try and work out how to turn that compliance obligation into an opportunity.

Dan Miles
Yeah, absolutely. I completely agree. And it is an opportunity to an engagement opportunity is an opportunity to understand clients better understand their values better. You know, I had an advisor describe this to me once and I still can’t get over that. You’ve, you go through a risk profile questionnaire, and at the end of it, you know, you get a score of four, so you growth. And it that’s, that’s a reasonably fixed level of risk tolerance the client has at the time, but instead of putting them into a portfolio that is managed to that level of risk, instead, they put into a fairly static asset allocation portfolio, and they give them variable risk. That’s the antithesis of what the result was supposed to be. If we If advisors are given the capacity to be able to have conversations with clients around more than just risk tolerance, and risk tolerance for associated with goals, but also risk capacity and risk need in association with multiple goals, I think we’re going a very, very low way to turning what is a currently a compliance, ticking the box exercise into a fully engaging value additive approach to providing a service for your client.

Fraser Jack
Yeah, I think risk profiling definitely come out of, of if it’s 20 odd years ago, back in the day, when we had, you know, five options on funds. And obviously, the options around funds, as is, you know, is a completely different world these days. And yet, we’ve sold a ton of work from a system that was created 20 years ago.

David Bell
Yeah, I agree. And you really sort of starting to push things along here, Dan, are you as well, Fraser and I sort of get back to my bugbear and that is I’m always advocating for clients to understand the financial literacy, financial education of their clients. And there are basic tests through to quite advanced tests and financial literacy around and the most famous test is called the basic financial literacy assessment test is any is a three question version is a five question version, it looks at things like Do you understand compound returns time value of money? Do you understand how mortgage pays down really, and do understand risk and diversification really, basic, foundational concepts, and globally and Australia’s no exception, only about 40% of the population pass that test that three five question test, and just sort of shows you how lacking those insights are. And so I think it’s hard to pack risk aversion without having a good sort of understanding of, you know, literacy and knowledge levels. And getting back to your comments, then I think they’re really good and bad goals and risk capacity. I think risk capacity in the goals conversation do really start to interact with each other, because the goals have to be in the content context of your capacity, your financial capacity. So I think is much far richer discussions that I’m sure the best practice advisors, they’re sort of trending down. For me, my probably my, my observation is that, I’d be very hesitant to use risk, I wouldn’t use risk aversion at the core of any sort of financial plan. But I do think you don’t want to necessarily throw out any useful information that you can discover there. And so if you frame it right, when you’re going through that discovery process, I then believe it has two useful applications. So one would be the education and the communication piece. And that is that if you sort of realize or assess that your client doesn’t have strong education, and, and you can broach that issue without offending them, and so forth, then anything you can do to uplift that education and peace and the way you choose your communication techniques, can really just add again, what I call advisor alpha, which is bringing people along on the journey, helping them understand the range of experiences that may have all this contributes to them being able to stay the course on a plan that’s been put in place and not exit at a poor time and, and put their outcomes at risk. So there’s, there’s a real piece there that I can see. I also think this sort of little bit of hand holding. Yeah. So think risk aversion does give you insights into the particular clients that you need to hold their hands and say, yeah, if you do have an assessment of risk aversion, you know, when you start to have your fast sell offs in markets, you’ve probably got the order of the clients in which to call them up and say, hi, yeah, these things happen once every five years, once every three years or whatever. Remember what happened the last few times but here’s some charts for you. Things do bounce back Things are now cheaper, etc, etc. And let’s just keep focused on the goals here. And, and, and you’re still on track to achieve them under this plan or we need to reassess.

Fraser Jack
Yeah, and there are a lot of eyes out there, just on your first point there around financial literacy. There are a lot of advisors out there now creating information. And, you know, there’s with the with the obviously, with podcasts and those sorts of things, and there is a lot more information coming out. It’s just a matter of making sure that’s good information. But that, but I think there’s a lot of conversations. Dan, I just wanted to bring up 1.2 that we haven’t thrown into this that you raised earlier. And that was the prioritization of goals. And how that can have an effect on on this conversation as well. Yeah, absolutely.

Dan Miles
Because, as David said, this concept of goals and capacity, sometimes you have to have tough conversations with clients where, you know, certain goals may not be able to be achieved. And so therefore, without a level of prioritization, how can you determine which ones you should be concentrating on, you know, to a greater extent than the others. And you usually find that the shorter term goals, you know, they’re there, they’re immediate requirements, and they’re, they’re usually things that they’re absolutely actually essentials. So they’re not necessarily goals, they’re essential, then they’re required for a basic standard of living. And then you’ll have things that might be more medium term, you know, throughout time where you may need to create some wealth, and then you may have aspirational goals, which, you know, could be, you know, further down the path that might be whether that charitable conversation that we were talking about earlier might come in, where you may have a completely different time horizon, therefore, different risk tolerance that’s associated with it. And I think without that, a recent basic form of prioritization of what those goals are, then you’re just going to try and achieve all of them. And if you try to achieve all of them, you’re likely to achieve kind of none of them. So let’s get some sort of level of prioritization. And in fact, guys, you were talking earlier about financial literacy. And I just wanted to quickly jump in I’m not an expert on this. But you know, there are a lot of advisers going down the financial literacy pasman part because ASIC and they’re acquiring advisors prove that clients understood the advice that was presented to them. So there’s now a regulatory requirement in a form and I like I said, I’m no expert, that you need to be able to demonstrate their some form of literacy of your client. So it’s almost an obligation that the the advisor have tools at their disposal to be able to help clients with literacy and be prepared to have those difficult conversations when they may not score that well. Like as David said, you know, if we get 40%, Australia, and that’s much different around the world, I probably bet that it’s up at the higher end compared to other areas of the world. I could be completely wrong, but from a lot of it, yeah. Sorry.

David Bell
I was just gonna say, um, Dan, Australia’s lucky we’ve got two of the world’s leading experts on financial literacy based in Australia, Hazel Bateman and Susan Thorpe, sort of rock stars in this pub industry. And they do lots of that work with with with with Australians surveys and studies and and maybe that’s an area that they can sort of, I think it’s mainly been we’ve institutions but maybe they should be saying to engage with financial planning community and working out what needs to be done there. Yeah, standardization is amazes me as an external looking at financial planning sometimes, how few processes are standardized across the industry anticipating jeez, if things are made open source available and easy to tap into and pick up it would disable a world of cost for these industry. Sometimes

Fraser Jack
I love the way we could describe them as rockstars of financial literacy we oxymoron we’re all leaning into that we’re all going that’s that we all think we’re rockstars in the financial industry world, financial literacy. Well, thank you so much for for jumping in and having a chat about that risk profiling topic. Gentlemen, we look forward to catching you in the next hour in the final episode of this series.