Many financial planners may have fundamentally misunderstood how their clients react in terms of risk tolerance in adverse markets and will need to change their views, according to a new paper developed by FinaMetrica director Geoff Davey.
In the paper, released this month, Davey claims the common view – that financial market risk tolerance is highly unstable and particularly subject to market conditions – may very likely be incorrect.
Instead, his paper argues recent studies, combined with anecdotal evidence gathered by FinaMetrica, suggests clients' risk tolerance scores remained remarkably stable through the most turbulent market conditions in living memory.
"Many advisers and others involved in financial advisory services will now need to change their views about the nature of risk tolerance, how it should be assessed and its role in the financial advising process," Davey's paper claimed.
It claims that the misconceptions around risk tolerance may be based on the fact that some financial advisors report that their clients' risk tolerance collapses in bear markets.
However it points out that, when questioned, the advisors said their clients wanted to sell out of investments with which they were previously comfortable.
"There is, however, an alternative explanation, namely that clients were not only over exposed to risk but also did not understand the risks they were taking until those risk actually eventuated," the paper said.
It said that it was in these circumstances that advisers needed to be more aware of the need to educate their clients about market risk.
