Accurate risk profiling is the “foundation of good advice”, the Financial Conduct Authority’s head of investment platforms Kate Tuckley has insisted.
She said moving from accumulation to decumulation is likely to change a customer’s attitude to risk, so this should be reassessed.
“Advisers should not assume that a risk profile remains the same, either when moving into decumulation or from previous advice meetings,” she added.
She made the comments during a keynote speech at Money Marketing Interactive in Leeds yesterday (24 October).
“A key risk is capacity for loss – the ability to absorb losses in retirement, which is critical given the lower future earning potential.
“Many customers may have been able to recover losses during their working years, but this changes in retirement.”
She cited the FCA’s thematic review of retirement income advice, which found that some advisers’ files did not show that capacity for loss had been assessed, or where it had been assessed.
“Clear consideration of this is crucial to demonstrate the suitability of advice,” she said.
“Cash flow modelling (CFM) tools can be used for capacity for loss assessments. However, firms need to assess both attitude to risk and capacity for loss consistently.
“Tools such as standard questionnaires can be useful, but you should be aware of their limitations, especially when the language or questions are not tailored to decumulation, which can lead to incorrect profiling.
“Whatever approach is used, firms must demonstrate that their methods are suitable for retirement income advice.”
Pension freedoms came into effect in 2015, giving consumers more choice and less prescription in how they meet their retirement income needs.
“They can take as much or as little as they like, or even fully cash out if they choose,” said Tuckley.
“As you know, there’s no longer a requirement to buy an annuity, and drawdown is no longer just for the wealthy.
“However,” she warned, “more choice brings more complexity, not just for consumers but also for advisers.
“Most consumers have moved away from guaranteed income for life and keep their pension savings invested, which presents a big challenge for advisers.”
She said advisers need to help consumers manage ongoing risks and make complex decisions about meeting their income needs sustainably.
The FCA is following up on the thematic review and is “completing further work” on retirement income advice, which Tuckley said will continue to be a “priority” in its strategy.
“We want to explore this in more depth to understand how firms are responding to our report,” she said.
The regulator aims to publish further findings in the first quarter of 2025.
I disagree, the foundation of proper financial planning is a detailed lifetime cash flow plan to discover a benchmark return required to achieve a desired outcome. If that turns out to be 12% per annum, risk profiling becomes irrelevant.
So, let’s assume we have two clients identical in every way apart from their ATR. Let’s say client A is very risk averse and client B is willing to take a normal amount of investment risk. Why should client A experience a materially lower return on their investment than client B? Shouldn’t the role of the adviser be to ADVISE how much risk to take rather than simply trying to make the client feel comfortable? Isn’t it the FCA that are saying that far too many consumers have their money in interest-baring savings account and are missing out on the returns available from equity investment?
Are we still to assume that bonds are safer than equities and people will lose less within this area, as it’s a 2/3 on the risk scale rather than a 4/5/5, because 2022/3 didn’t exactly reflect this, after the budget debacle and let’s remember that we now have another chancellor looking to raise our debt (for what of a better slant on it), which could again significantly affect bond markets and returns.
This is what we, as advisers have to contend with alongside everything else we are expected to predict!
At least as important as risk profiling, I suggest, is managing client expectations so that, for example, their reaction to a couple of negative valuations isn’t completely at odds with the answers they gave to the questions on the Risk Profiler.
I agree 100% with Christopher Pitt – most clients will need to be advised as to how much investment risk they will need to accept in order for the achievement of their objectives to be a realistic (not guaranteed) expectation – and to state what the fall back plan will be should investment returns fall below expectation. Those who either require guarantees, or too little risk to satisfy their objectives, from an emotional or affordability viewpoint, should buy annuities. Portfolios may require greater emphasis on yields once regular income withdrawals are required, not not necessarily less overall risk. Elaborate questionnaires and risk profiling software will not provide answers – though too many believe they will absolve their firms from responsibility for making meaningful judgements. They won’t.
In the two extremes I recall my own advice. To the vey risk averse – “You are not suitable for equity investment – just save in a high deposit bank account” And to the very highly risk tolerant ” You don’t need me – go to William Hill”. Those in the middle were my clients.