Understanding your clients' risk profile

If you know what drives investor behaviour, then you are one of the few who understands your client's risk profile.

Warren Buffet's rule number 103 is "It won't be the economy that will do in investors; it will be the investors themselves." Most risk profilers push the investor towards a product or service. It is the investor who usually ends up with a product that was structured according to his or her emotional state-of-mind on the specific day the risk profile was done.

If we had a more in-depth knowledge of investor psychology we would appreciate the answer on the following question: How will you react if you lost a big chunk of the paper value of your investments today?

Different reactions

Most of us will definitely be stressed out and liquidate everything, usually at the bottom of the price curve. Some will hold onto their investments no matter what. Others will even be oblivious to the fact that the paper values have dropped because they are long term investors with sufficient reserves. Then there will be those investors who will look for someone whom they can sue.

Challenges

Most of the time financial advisers work with investors who do not have sufficient savings, knowledge and experience, and who, in addition, lack the psychological make-up to relax when markets go south. People have selective memories. They will remember only those facts that will be to their advantage.

Bad habits

Here are some of the things we as investors do:
* Selling our winners and keeping our losers because we do not want to take a loss.
* Investing at the end of bull runs and disinvesting at the end of bear markets.
* Being drawn into the markets when there is a track record of outstanding returns thus driving forward while looking in the rear view mirror.
* Being over-confident when markets rise and focussing on positive news.
* When we have gains we tend to congratulate ourselves on how clever we are and when things go wrong, blame it on something or someone else.
* Hindsight is perfect.

Planning for a long life

We know that compound interest is one of the world's wonders. Therefore, if we have time on our side then the outcome of our investment decisions will turn out well. There is a tendency though to think that the moment a person retires, he or she needs to avoid risk. The fact is that most retirees will live a long life. Investment planning does not take into consideration the next month or year. We have to plan for the future and thus for the life expectancy of the retiree. It is ludicrous to assume that such a person is now suddenly a conservative investor. I know of some investors who are 70 years and older and are far more aggressive investors than most people. The difference is that they are involved with their investments.

The right questions

It is imperative that we focus on the right questions and use the information gained from the answers to come to an agreement which is acceptable to the investor and then to align this with an acceptable investment management mandate.

Obviously it is having an understanding of what the investor wants. This includes knowing how he or she will react when things go wrong and contracting with the investor in an understandable way so that the total relationship is fully covered and FAIS compliant.