How does risk profiling work? [video]

In this video you'll learn:

• how Robo-advice can be dangerous;
• why it's important to work out your risk profile; and
• when to seek professional financial advice.

Transcript

Robin Powell: Hello there. Perhaps the biggest development in the investing industry today is the rise of so-called Robo-advice— automated portfolio management, with minimal human interaction. For many people, particularly younger investors who don’t have large amounts of money to invest, these online services are fine. But it’s important to beware of their limitations.

Neil Bage is the co-founder of a company called Suitable Strategies and an expert on financial behaviour.

Neil Bage: The Robo-advice services that we see we look at and we think “Wow, why wouldn’t you buy from them? They’re making it sound really easy and simple and cost-effective and I can manage my investments, I got full control.” You know, so it’s framed in a very positive and rosy light, they kind of entice you in and I think that is really quite dangerous.

Robin Powell: Because investing is inherently risky, it’s vital to work out your risk profile — in other words, your willingness to take risk — before you invest.

For Neil, simply completing an online questionnaire is not sufficient.

Neil Bage: The first problem we have is, in an online world, that methodology was designed for a face to face discussion, it was designed for you looking at me, the whites of my eyes and asking me questions and assessing my attitudes to risk-taking. That’s how it was designed. It was never designed to be put into an online world. And what people are doing is, they are taking that methodology and are just putting it online and allowing customers to do it themselves. They are removing the whites-of-the-eyes conversation. That’s a really crucial missing piece because the whites-of-the-eyes conversation is more than just asking questions. I can pick up on the twitches in your body, I can pick up on the little movements on your face, so when I ask you a question, I am actually gathering a lot more information than just ten questions.

Robin Powell: Another issue is that a person’s risk tolerance is very subjective. An investor isn’t necessarily the best judge of his or her attitude to risk.

Neil Bage: We ask people a series of questions and we ask them: “What do you think you would do in this given situation?” And what psychology has proven time and time again is that humans are not very good at putting themselves into a future state and answering a question with any degree of authority. We can’t do it.

Robin Powell: The lesson here is that, if you’re in any doubt, you should seek professional financial advice. Even if you subsequently decide to invest online, paying for an accurate risk profile is a sensible move.

Neil Bage: People need to be more self-aware and people need think: “Do you know what? I think I know this, but let me just make sure I do, really.” Because these are quite critical questions. This isn’t “Do I want a cup of tea or do I want a cup of coffee?” This is a decision that will affect my life for the rest of my life if it goes wrong. If I lose all my money on a bad investment or a bad financial strategy, that’s a damaging thing to happen. So what I would suggest people do is kind of stop and say: “Am I really able to make this decision on my own?”

Robin Powell: Thank you to Neil Bage, and to you for watching. Goodbye.