How to better understand your clients' attitudes to risk

Recently, the FCA has been keen to reach a better understanding of how advisers can calculate a person's attitude to risk. Are risk questionnaires really working? Are advisers 'damned if they do and damned if they don't'? Tony Catt delves deeper.

Recently, the FCA has been conducting roadshows discussing people's attitude to investment risk. I have often wondered whether our regulators actually understood risk and what it meant to advisers and clients. The following is what I understand to be its views, which I think could make us all take a different perspective on risk.
The FCA has laboured the point that advisers need to ascertain the clients’ attitude to risk before advising clients about how to invest. Over time, the approach has become ever more detailed. Historically, advisers would have a list of definitions and the clients would tick the closest to their view of themselves. Gradually, this moved onto questionnaires involving a list of questions with different answers getting weightings and then tallying the scores and matching them to their list of definitions. Now the questionnaires can be done online and the calculations are made by a system that then spits out the most apt definition.
The authority has advised that most of the questionnaires do not actually do the job very well. This has left advisers thinking that they are damned if they do and damned if they do not! The FCA has said that a couple of the questionnaires are adequate but, in their normal manner, will not advise which ones! It says guidance has been given to all of them and they should all do the job better soon.
So, if the questionnaires do not do the job, how can we ascertain risk? The start is a good quality fact find with as much detail as possible, but as a minimum this needs to include

  • Age
  • Health
  • Marital status
  • Residence status - domicile
  • Employment status
  • Income and expenditure
  • Assets and liabilities
  • Borrowing – amounts and terms including interest rates, redemption penalties
  • Protection – amounts and terms and types of protection.
  • Savings – types of plan or deposits
  • Investments – types of plan, amounts invested
  • Retirement planning - types of plan, projected benefits

Then we move onto soft facts that will involve ascertaining the clients’ objectives, in order of priority, timescales involved, and amount of money available, if any, to cover each objective.

While this seems to be a lot of information, this is normally quite nicely covered by a fully completed fact find. With lots of notes. Most CRMs provide decent fact find documents, why do advisers still use rough paper?
Borrowing is a higher risk than an investment because it is invariably based on a rigid repayment schedule and there are consequences of not keeping up that schedule. Either penal interest rates and a poor credit rating or in the case of mortgage related borrowing, the repossession of a home. So the consequences of not keeping to the payment schedules are very serious.
This leads to the principal, risk must have a consequence. Without a consequence, there is no risk. Personal liability focusses the perspective of the level of risk.


As any adviser knows, attitude to risk is a very important subject and it is does not only relate to investments. It should also be considered when looking at all aspects of financial planning – borrowing, protection, savings, investment and retirement planning. It is the consideration of the consequences to the clients of various risks.

The FCA has stated that the risk questionnaires are a valuable tool that can be used in assessing the attitude to risk, but they should form the basis of a much wider discussion of the client’s circumstances and objectives and the priorities of achieving those objectives. The use of the questionnaires is certainly not obligatory, particularly in light of the FCA stating that the questionnaires may not be fit for purpose.

Therefore, the way of personalising the attitude to risk is to consider should be in the following terms.

  • Willingness to accept risk
  • Ability to take risk
  • Need to take risk


This is the measurement that can be taken using the risk questionnaires. This measures the attitude of the client to various scenarios and comes out with a score. That score can then be matched to a definition, such as defensive, cautious, balanced, aspirational and adventurous. These are given various different names: low, medium, high and grades in between. They are broad brush and it is likely that a client will have a different attitude about regular investments, lump sum investments or retirement planning. The acceptable level is likely to be different with earned or unearned money.

This willingness will also govern how long money is to be invested for. If there is a longer term, then a higher level of risk is likely to be acceptable.

This willingness to accept risk may well set the level of risk that is to be considered, particularly with investments. This risk level is used to choose the types of investment, asset classes to be used for investment strategy and the weightings between these asset classes to build an investment that matches the client’s comfort level to try to achieve their objectives.

A well balanced investment portfolio will include a mixture of asset classes in geographical locations around the world. It may well be that some the funds appear to be higher or lower than the suggested risk profile, but as a whole the portfolio will match the client’s “attitude to risk”.

However, willingness to accept risk is probably the least important consideration.


The capacity for loss is one of the issues that needs to be taken into account when considering the level of risk. This governs the ability of the client to consider taking a risk. If the client cannot afford loss, then they cannot afford to take the risk. And therefore cannot take the risk.
The toss of a coin
If a normal heads/tails coin is flipped, the odds of it landing on either heads or tails are 50/50. These odds are the same every single time the coin is flipped. The random nature of the flip of a coin means that it can land as a head 10 times in a row, but the odds of an eleventh occurrence are still 50/50.

But the risk involved can be quite different in various scenarios.

  • The first flip: produces a win or a loss
  • The second flip: if the bet is double or quits, if the person won first time, the second flip is a free bet, as the worst event is simply back to no loss
  • The second flip: for the loser of the first flip, the loss could be doubled with the best result possible being no loss
  • Higher stakes: a loss or win will be greater. The extent of consequence of loss depends on the ability of the loser to write off the loss

This also leads on to the perception of risk and the value of the stake.

  • The first flip: both parties staking their own money
  • Second flip: winner of the first flip – free bet, no risk of loss
  • Second flip: loser of the second flip – staking more of their own money

At what point should the winner cash in? When they feel that they have reached a value that they would not want to lose.

At what point should the loser stop? When they have reached a value that they can afford to lose.

If a person walks away with £100 winnings, they are likely to quite happy. If that person had actually won £1,000 but then lost £900, they walk away with £100. Is that person likely to be as happy as the first person? Probably not, but they have achieved the same result.

On the other hand, if a person walks away with £100 loss, they are likely to quite unhappy. If that person had actually been down by £1,000 but recovered £900, they walk away with £100 loss. That recovery may well leave that person losing £100 actually quite happy. Even more so, if the loss of £1,000 would have had any adverse consequences on their lifestyle because they could not really afford to lose that much.

Business start up

The entrepreneurial mantra of “speculate to accumulate” comes under this heading. It is not often that any gain can be made without taking some kind of risk. The level of risk starts with the willingness to take the risk and then the ability to take the risk.

Four people looking to join together to start a new business. The costs have been set at £10,000 each.

  • If a person has £100,000 in the bank, the stake represents 10 per cent of possibly disposable cash. Not a high risk unless that money was earmarked for alternative use
  • If a person has £10,000 in the bank, the stake represents all of their fund. Using all of their money is a risk
  • If a person need to take a loan to raise the £10,000, this is a greater risk
  • If a person needs to borrow and use their house as security for the loan, the risk is very high as they could lose their house if the business fails

The initial level of risk taken will probably also govern the determination of the people concerned to make the business work to get their money back or protect their investment. The person with the secured borrowing is much more likely to be focussed than the person using a small amount of their own assets.


Since personal liability offers the greatest level of perception of risk, borrowing offers the greatest risk level. Therefore, it should be cleared as far as possible before considering major levels of investment. Borrowing is generally at a higher interest rate than is available from risk free savings. Therefore, if someone is borrowing on a credit card at between 15 per cent and 30 per cent, this should be cleared before making an investment that is unlikely to generate this type of return.

There are three types of people:

1. Those who borrow to spend

2. Those who spend all their money

3. Those who do not spend all their money and have excess money to save or invest

It is generally accepted that most people need to borrow to buy their home, but most other borrowing is discretionary. Due to the size of mortgage related borrowing, the interest rates to tend be lower and it is spread over a longer term to repay.
It makes good sense for people to hold an emergency fund in cash or close to cash deposit to cover urgent expenditure or to cover temporary shortfalls in income.
It does not make sense for investments to be made, other than the emergency fund, whilst there is short term borrowing outstanding. This only makes sense if the guaranteed return of the deposit is higher than the rate of borrowing. Otherwise, the investor is actually paying interest on their own money.
Maintaining liquidity is often used as an excuse to make investments rather than repaying borrowing, but other than an emergency fund, this liquidity is actually costing the client money and the costs of that need to be weighed up against the benefits of having that money available.
While borrowing is outstanding, it sets a hurdle rate for any investment. If borrowing is at 10 per cent, the investment return needs to be higher than 10 per cent to make it worthwhile. Due to the constant nature of the borrowing rates, the investment return needs to be at least as constant to be effective and that would probably require some kind of guarantee to be in place.

Just because a person has the capacity to accept loss and the willingness to take a risk, the need to take the risk needs to be assessed.
Need is the measure of the consequence of risk. What is the priority of one objective over another? What is the consequence if an objective is not met or a target not achieved?
A person that wants to take income from an investment will have a different perspective from another person simply looking for capital growth. If the generated income is sufficient for their needs then the objective has been met. If the income falls short, then the shortfall may have different consequences depending on the amount of shortfall. Whereas, a lower capital growth than expected does not have any consequences, unless it has put an objective less likely to be achieved.
If a person has £100,000 invested and wants to generate £10,000 per year income, a 10 per cent return, they may have to consider taking significant risks to achieve the target income. Because the level of income is so high, their choice of methods of generating the income may also be reduced, thus increasing further the risk involved.
If the same person only required £1,000, a 1 per cent return, they could probably achieve this at a much lower level of investment risk, possibly even without risk if they used cash deposit accounts.

If this person has a willingness to accept risk that has been classified as balanced or medium, should their investment strategy be in line with their attitude to risk? Do they need to take that level of risk to produce the 1 per cent return? No. They can take a much lower level of risk.

However, the balanced or medium level of risk may not be likely to generate a 10 per cent return, not under current investment market conditions. So it is necessary to manage their expectations. They may not be comfortable accepting the level of investment risk that would generate the 10 per cent return. So that route may not be available. The balanced investment is likely to produce a shortfall. What is the consequence of this shortfall? How important is the objective that they have set?

This is where the original fact finding becomes important. Something as basic as income and expenditure is so important. This is often derided by advisers as being patronising to clients, but it is important when considering the objectives of clients. Also, the ability of the clients to generate the required income from other sources – work, state pension or other investments available – is important for an adviser to know.

So a client with adequate income to meet expenditure has a much lower need than a person that has a shortfall of income against expenditure. If the person wants the investment to generate sufficient money to go on two holidays a year, what is the consequence of the investment only generating enough for one holiday? If the investment was to generate enough for one holiday, and it fell short, meaning that no holiday could be financed, this consequence would be greater than going down from two to one. If the person needs the income to cover formal outgoings and provide a basic standard of living, any shortfall is likely to have adverse consequences.

Spreading risk

This is a very important consideration. People are familiar with the term “not putting all your eggs in one basket”. This spreading of risk is occasionally misunderstood. It is not restricted for use on investments and pension funds.

The FSCS compensation scheme has led many people to restrict their deposits to £85,000 in any one provider as this is the level that is covered by the FSCS.

Now with the emergence and evolution of platforms, the provider risk does not tend to be spread as it was. The platforms are very convenient for advisers and clients to be able to deal with all their investments in one place. The insurance companies have seen this trend and are wither starting their own or linking to a platform provider in an attempt to protect their book of legacy business.

Therefore, the most common spread of risk is to set up a portfolio of funds. There are various tools in the market to assist with this process. Advisers are also moving towards de-risking their own business by outsourcing the fund management. Either using model portfolios set up to cater for varying levels of perceived investment risk or for larger funds, appointing Discretionary Fund Managers. The de-risking is an acknowledgment by advisers that most of them lack the knowledge to run money for clients and also that it is time-consuming. Whilst advisers cannot be blamed for adverse results due to market movement, if they have set themselves up as investment experts, the clients may well have some leverage to complain. Have portfolio reviews been undertaken? With the promised regularity? What processes are involved? How robust is the proposition?

Attitude to risk questions

As discussed previously, the risk questionnaires may not actually do a particularly good job. The questions tend to be quite difficult to understand and often even the advisers do not see the point of the questions. A fairly unpleasant part of any advice process for all concerned.

Then, more often than not, there is very little change in the score and therefore what has been achieved by the process of going through the questionnaire again?

In actual fact, the best questions to ascertain attitude to risk come back to basic fact finding questions to the clients? What has happened to you since we last met? Have your circumstances changed at all? What are your current life objectives? Short term? Long term? Priorities?

If a person has changed jobs – are they self-employed or employed? Working full-time or part-time? Are they earning more money? What is their pension arrangement with their new job? Have their employee benefits changed?

How long to retirement? What pension arrangements are in place? Are they on target to achieve the required income in retirement?

If they have investments, how have they done? What is there view of how they wish to continue?

Have they changed their view about short-term cash requirements? Looking to change cars? Home Improvements? Holidays? Can they get hold of their money to finance these?

Looking to move house? So they require borrowing? How is their mortgage being repaid? What rate are they paying, for how long?

Is the level of various protections still valid to them? Have their views towards protection changed? It is not surprising that many people change their view of the value of critical illness, if they know somebody that has suffered a heart-attack, stroke, contracted cancer etc.


As can be seen from the questions above, a person’s attitude to risk is likely to be much more accurately gauged when the questions are personalised rather than using an impersonal attitude to risk questionnaire.

The main issue is to evidence the discussions that have taken place. The whole issue is about attitude to the consequences that arise from various risks rather than the “scores on the doors” produced by the risk questionnaires that are available.

This will probably go against the grain for many compliance departments. The compliance departments take comfort from and often insist upon the regular completion of the questionnaires. However, if they really considered the issue, the questionnaire does not actually assess the attitude to risk. It is merely measuring the willingness to take risk, which is the least important element of the equation.

On reflection, this would appear to be another attempt by the financial services profession to try to convince the outside world that people need advisers by making attitude to risk something esoteric. This is coupled with the attempt to take short cuts and easy options to achieve goals, which have previously been sales. The questionnaires are invariably full of jargon that even the advisers have difficulty in understanding and therefore have little chance of interpreting accurately for their clients.

As a profession, advisers acknowledge that the questionnaire is only a minor part of the process and that the most effective method of ascertaining attitude to risk as to go back to the basic principle...

... know your customer

Without knowing your customer, your advice is unlikely to be suitable.

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