Investors’ ability to withstand risk has remained fairly stable through the bull market of 2003-07 and the subsequent bear market, according to a new report by FinaMetrica.
The Australian risk-profiling company says that most surveys that try to gauge investors’ risk tolerance only account for risk tolerance but not for risk perception.
“Not only will risk perception have been a factor at the time the investment decision was made but, if there has been no rebalancing, the current proportion of stocks/shares/equities will be attributable to market rises and falls in addition to any investor characteristics,” the report stated.
One reason clients might to decide to sell out of investments during a bear market is that they were “over-exposed to risk but also did not understand the risks they were taking until these risks actually eventuated. That (some) clients will be over-exposed to risk should come as no surprise because studies show that advisors’ estimates of their clients’ risk tolerance are highly inaccurate,” the report found. Further, industry-standard risk questionnaires tend to be biased toward higher risk/return outcomes and advisors are significantly more risk tolerant than their clients, which only increases the likelihood of over-exposure to risk, the report stated.
FinaMetrica has been publishing monthly average risk tolerance scores since 1999 and has completed 500,000 tests to date. The data is drawn from Australia, the U.S. and United Kingdom. The company found that Australians are more risk tolerant than Americans who are more risk tolerant than the British.
“This is good news for advisors. Advisor and client share a common interest: neither wants the relationship to end in disappointment, and both want to reduce the potential for abrupt reversals. If the client’s risk tolerance collapsed in a bear market there would be little the advisor could do to prevent a panicked sale. However, if increased risk perception is the likely Achilles heel, then the advisor can influence the client’s risk perception through education about market risk,” the report found.