Reconfiguring the risk profile - My Kaplan...Reconfiguring the risk profile July 2016 • 5...

July 2016

July 2016 • 1

Overview

The risk profile is part of assessing a customer’s investment needs and preferences. It is useful in identifying a person’s risk tolerance, their risk capacity and the amount of risk they may need to take on to meet their wealth objectives. Unfortunately, this is where the current risk profiling process stops.

That is not to say the risk profile is broken, merely that it needs to be augmented with a host of other questions and further segmentation of personality types.

Featured contributor

Learning objectives After reading this article you should be able to:

Suggest ways to enhance the existing risk profiling and fact-find process

Recognise “wider” factors not captured in current risk profiling methodology

Discuss key traits of the four personality types discussed in the article, particularly in light of resilience and financial literacy

Apply appropriate methodologies to manage clients in accordance with the personality types discussed in the article.

Knowledge areas and accreditation Knowledge area: Skills (60 minutes/1.0 point).

FPA CPD points 1.0 Dimensions: Critical Thinking (FPA 007961).

AFA CPD points 1.0 (AFA 01022009).

CPA Australia CPD points 1.0 (CPA 000063).

FBAA CPD points: 1.0.

Matt Heine ● Joint managing director ● netwealth

Reconfiguring the risk profile


July 2016 • 2

The need to transcend the risk profile The risk profile is not a wonderful tool for determining whether a person has a preference towards ETFs or managed funds, or for that matter European large caps versus US large caps. Further, for those clients who do not know the difference between an ETF and a managed fund, the risk profile provides no information on the ways in which a client needs to be educated or engaged through the advice process.

Today, advisers also often rely on categorising people by their life stage. This needs-based model provides more information regarding clients’ investment desires and preferences. However, is using a life-stage segmentation model enough?

There are many commentators who suggest a risk-profile tool is inadequate for meeting the best-interests test. Or if it does, it has little to do with meeting a client’s objectives. Further, the tool itself often uses language which assumes a certain level of financial literacy or financial experience.

How does a person really know how they will act if the market goes down 20% if they have never had such an experience?

As a result, this tool often misestimates a person’s risk tolerance, particularly those with low literacy. Also, the tool pays no attention to the type of product which is best suited to the customer. For instance, do they prefer passive investments, shares or managed accounts?

Where the risk profile sits with the powers that be

Interestingly, it is not an ASIC requirement to perform risk profiling or a psychometric test on clients.

What the corporate regulator wants to see is an appreciation of how risky various asset classes are, and how risky a recommended product is.

FOS supports the notion that advisers can use a variety of risk profiling methods, but when selecting a method, its weaknesses and limitations must be addressed.

When assessing a complaint, FOS will investigate the risk profiling tools that were used.

The traditional risk profile framework: pros and cons So, what other profiling methods are available to advisers?

Consider

Did you know?

Did you know?


July 2016 • 3

Before answering that question, it is worth examining the pros and cons of the traditional risk profile framework.

It is good at determining an appropriate asset allocation model, by virtue of a person’s risk capacity, investment timeframe, the required risk and arguably a person’s risk tolerance.

However, it tells the adviser nothing about the client’s preferences regarding:

Investment products (e.g. ETFs versus shares vs funds vs managed accounts)

Investment strategies (e.g. active or passive)

Cost

Their preferred investment structure (e.g. wraps, SMSFs or low-cost industry funds).

Further it does not assist in helping the adviser determine an appropriate relationship and engagement model.

Some questions to think about include:

Should the adviser educate the client as to what the best options are – warts and all?

Should the adviser offer inspiration and expert investment insights?

Should the adviser just take control, providing limited information to the client?

What involvement does the client want to have in selecting the investment products?

What levels of transparency in investment does the client require?

Does the client want to manage a proportion of the portfolio themselves? How much of their investment management do they want to “DIY”?

As a result, many advisers already try to understand these preferences through a host of further profiling questions, beyond the initial risk assessment.

Resilience and literacy customer needs framework Following is an operational framework based on research conducted in conjunction with Australian ethnography and brand strategy agency The Lab with regard to the behaviours of Australian investors and financial adviser clients.

This research was based on face-to-face meetings and online focus groups with advisers, their clients, and self-directed investors.

The Lab analysed numerous existing reports and ultimately came up with a number of findings through rigorous strategic analysis.

Among a number of interesting findings was the identification and creation of a sophisticated method to profile investors, providing a unique and simple way to understand clients’ financial needs and preferences

This was named the “Resilience and literacy customer needs framework”.

Consider

http://thelabstrategy.com/


July 2016 • 4

Four client segments

This framework divides Australians into four different types of consumer segments based on their financial literacy and their overall resilience:

1. Aspirer – with low financial literacy but high resilience

2. Explorer – with both high financial literacy and resilience

3. Disengaged – with both low financial literacy and resilience

4. Maverick – with high financial literacy, but low resilience.

This profiling tool enables a better understanding of customers’ education, communication, engagement and investment needs.

Further, it is something that builds upon current activities. It is not a replacement for the risk profile, but an extension. It fills many of the gaps left by the traditional risk profile process, as identified earlier.

Two elements

The framework is defined by two elements:

1. Financial literacy

2. Resilience.

Financial literacy

Financial literacy is the ability to understand financial products and structures to determine an appropriate solution for personal circumstances.

Further, it refers to one’s ability to understand financial products and structures and to determine an appropriate solution for one’s personal circumstances. People develop financial literacy through education and experience.

Financial literacy is not determined by generation, and it is independent of gender and life stage.

How financially literate are one’s prospects or existing clients?

Unfortunately, a large proportion of Australians sit at the low-knowledge end of the financial literacy spectrum because they:

a) Have never been taught about wealth management

b) Do not have the time to learn about wealth management

c) Do not have the inclination to learn about wealth management

d) Have been taught, but do not have the necessary experience.

Interestingly, financial literacy does not reflect how intelligent or successful an individual is in other pursuits.

Resilience

Resilience can be thought of as one’s ability to set long-term goals to reap the rewards of investments in the face of possible short-term failure.


July 2016 • 5

Resilience can be learned, and arguably, objective advice by its nature tries to assist people move from low to high resilience.

When these two dimensions are combined, we end up with the four consumer segments (listed earlier), with each corresponding personality type having very distinct investment goals and signifiers of success.

Probably the most interesting segments are the first two — Aspirers and Explorers — as they are characterised by higher resilience. That is, they have a longer-term focus, which typically means they will make for better financial advice clients.

To this end, a stronger consideration has been placed on these two segments.

Key traits of the four client types

The Aspirer

It is worth keeping in mind that the Aspirer is categorised as having low financial literacy, so in the context of their future wealth wellbeing, the Aspirer wants to be:

Inspired

Educated

Supported.

Often these people are successful in their own right, but just lack the financial experience to manage their own future-wealth, and want their adviser to “show them a brighter future.”

They are looking for a coach, mentor and partner who shows them the possibilities of what can be achieved, shares knowledge about how to go about getting there, but supports them along the journey.

The role of the adviser here is to act as the “creator” of a roadmap - laying out the options, alternatives and possibilities. The adviser coaches the Aspirer along their wealth journey.

If the adviser is successful, the Aspirer will feel empowered and in control of their future financial wellbeing.

For an adviser to best position themselves to capture the hearts and minds of the Aspirer segment, they will need to provide a simple-to-understand financial roadmap that helps them learn and grow their financial knowledge.

Elements of this type of financial advice service could include:

Tailored financial education via investment seminars or webinars

Compelling editorial content and financial education distributed online, with a focus on human connection

Self-learning tools and calculators

Easy-to-understand risk profile target asset allocation and benchmarks

Transparency – both in fees and investments (e.g. ETFs, Managed Account, Top20 ASX)

Automated rebalancing

Constant feedback on their financial health


July 2016 • 6

Clear simple reports on performance of their investments versus their objectives

Access to ad hoc financial guidance – a safety net when they need it.

The Explorer

The Explorers are financially literate and resilient, have a wealth plan or already have achieved it.

This cohort understands the concepts of diversification, market timing and the difference between financial products and structures.

They are likely to be DIYers, heavy readers of business and economic news, financial newsletters and so on.

Although often preferring to DIY, the older people in this segment probably have multiple advisers – ranging from their accountant, to lawyer, financial adviser or private banker.

That said, they are not looking for a typical advice relationship. Primarily they are looking for their adviser to show them something they already do not know, or something different.

Unlike Mavericks, they understand that an investment is not a “quick win”, and it must be methodical, measured and considered.

This is a group with whom it will often be harder to establish relationships, but will most likely be loyal if this is achieved.

Giving this highly knowledgeable client segment the service and advice of a calibre they expect necessitates staying up to date with the market in great detail and being ready to justifying one’s actions if scrutinised.

For an adviser to best position themselves to capture the hearts and minds of the Explorer segment, they will need to provide them with a sophisticated investment service, one based on tailored thought leadership and insights to “enable them to see their future differently” — while keeping in mind they already know a lot. That is, a service that lets them “do more and grow.”

Elements of this type of service could include:

Thought-leadership education via white papers, webinars, video updates

Broad access to investment ideas and investment types

Personalised and curated business and economic news

Detailed reports on their total wealth

Sophisticated modelling tools

Access to a broad range of investments

DIY investment via SMSFs/superannuation wrap.

The Disengaged

With low financial knowledge and low resilience, these people really need assurance and their hands held. Thus, the adviser may be put in a position of almost acting as a life coach, rather than an investment coach.


July 2016 • 7

The role of the adviser is to educate and to build basic skills and confidence so that the person can be “wealth-successful”.

Robo-advice is probably not the best approach for these people as they want/need a lot of hand holding. Of course, not all financial advisers like hand-holding their clients.

The Maverick

This group often wants high returns quickly. With high financial knowledge — which sometimes may only be perceived, without substance, and not real — and an attitude of wanting quick wins, shortcuts to success and a short-term focus, Mavericks can often present the most risk for an adviser.

When dealing with Mavericks, the role of the adviser may entail taking a contrary approach, reigning them in, explaining the risks, and educating the person because they often do not have the financial literacy levels they should.

Advisers should give careful thought as to whether they really want Mavericks as clients.

Getting to know the literacy and resilience segments

Ben, aged 59, and Christine, aged 56, are recently divorced. They have a 27-year-old daughter, Chloe, who has a new boyfriend Stuart (who is older, aged 48, and also recently divorced).

Ben

Baby boomer Ben is starting to get anxious – not about his finances, but about what he is going to do with the next 20 years of his life.

He has been a dentist his whole life, having built up a sizeable practice.

He has used his discretionary income to invest in property (he now owns four investment properties), some managed funds which a financial adviser put him into some years back, some blue-chip stocks and some stocks in poorly performed mining companies.

He would describe himself as progressive, uses technology such as Skype and Facebook to communicate with his friends and children, and even likes some of the music his daughter listens to. That said, his daughter would describe him as “conservative”. On reflection, he would probably agree.

Ben is old enough to have been involved in a few “get-rich-quick” schemes, which failed, but is lucky (or risk averse enough) to have not gone “all in.”

Consider

Consider

Case study


July 2016 • 8

During the GFC, he was fortunate to have some spare cash, so bought some global tech stocks, Google and Apple.

Ben’s likely resilience/financial literacy profile

In terms of resilience and financial literacy profiling, Ben would best fit the Aspirer category, with the following needs and wants:

Investment needs:

Wraps, SMSFs

International equities, hybrids

Strategies — active versus passive, dynamic versus strategic

What they want from their adviser:

A “trend spotter” to offer inspiration and to help them see things differently and better

A considered and pragmatic approach

To feel involved in the process.

Christine

Christine loves the fact that for the first time she feels financially and socially independent.

She recently decided to retire from what was a great job as the marketing manager of a boutique cosmetics company. Now with her spare time, she watches movies, goes to the gym, eats out with her friends, and enjoys shopping and holidaying.

Her attitude to wealth is to “live in the moment.” She has worked all her life, so why should she worry?

Her ex-husband was a successful investor, which she thinks was a result of him taking lots of risks (but she does not really know). Thus, she says she would be comfortable with a higher-risk investment, saying “Without taking risk, there are no rewards in life”. This potentially reflects her state of mind at the moment.

Christine’s likely resilience/financial literacy profile

In terms of resilience and financial literacy profiling, Christine would best fit the Disengaged category, with the following needs and wants:

Investment needs:

Industry funds or basic bank offer

Investment products (via advice)

Non-automated investment services, as they want/need a lot of hand holding.


Financial advice and emotional support

Guidance and control through the process to make things easy.


July 2016 • 9

Chloe

Chloe is a typical Gen Y. She has grown up as a “technology native”, a first-hand witness of the GFC. She had difficulty in getting her first job in light of high unemployment rates for youth, although she is highly educated. She has low levels of trust with government, big brands, advertising and anyone trying to give her “advice”. That said, she is still very positive and optimistic about her long-term future.

Chloe has a great job as a software developer, but dreams of starting up an online female fashion store, citing Evan Spiegel (founder of Snapchat) among her heroes.

She still lives at home, saving her income, but is not entirely sure whether she will buy a house or go overseas to live. That said, she is conscious that her superannuation is her money and that investment is about the long term, not “quick wins”. She acknowledges that she needs to learn a lot more about investing.

Chloe has heard of ETFs from her friends, and has recently bought one (with her limited savings) that tracks the Nasdaq100. She likes them because they are low cost, but increase in value over time — which she has plenty of. She wishes she could purchase them through her superannuation too.

Chloe’s likely resilience/financial literacy profile

In terms of resilience and financial literacy profiling, Chloe would best fit the Aspirer category, with the following needs and wants:

Investment needs:

Retail fund options

Automated investment services

SMAs, ASX equities, ETFs

Online educational information and tools.


A coach/mentor offering them wisdom, showing them a brighter future

Mapping out the possibilities, warts and all

Simple charts/tools to explain concepts.

Stuart

Stuart is partner of a law firm and lives in large inner-city apartment. He has somewhat successfully navigated a mid-life crisis. His two children have just started university.

He is a Gen X, so his identity was shaped by a mix of disappointment and fragmentation. He grew up with hip-hop music, Nirvana, the AIDS epidemic, video games, high levels of divorce, The Simpsons, and underground culture like rave parties and “no logo”.

Stuart is a leader, with a strong desire to create new “rules”, yet is comfortable with deadlines and is outcomes focused. Some describe him as having a lot of “grit” and “determination”. He likes having a good time, but work and family come first – and that seems to be consuming most of his time.

When asked about wealth, he says proudly, “I have an SMSF so I can buy art to put on my walls. However, I must admit I have little idea about the concept of wealth. I want to get


July 2016 • 10

on top of it, as time is running out to provide a good legacy for my family. That said, I really don’t have the time, so I am going to need some help.”

During the GFC, he sold the only stocks he owned, worried that he would have nothing at all at the end – he is ruing that decision.

Stuart’s likely resilience/financial literacy profile

In terms of resilience financial literacy profiling, Stuart would best fit the Aspirer category, with the same needs and wants as Chloe.

Analysis

When we plot these four people using a traditional risk profile compared with the resilience/financial literacy framework we get a completely new perspective of their investment needs. These results are depicted in Figure 1.

Figure 1: Comparison of traditional and resilience/literacy profiling


July 2016 • 11

The new approach tells us about the specific products they may be interested in and the relationship they expect from their financial adviser.

Notice that age, generational attitudes, life-stage and risk profile do not influence this approach at all.

Putting it all into practice Some advisers may already be using the financial literacy and resilience customer needs framework, or an equivalent, informally. Thus, this framework can act as a tool to help advisers do it more consistently.

Implementing the framework should not be difficult, as a fact find is already conducted. Therefore, it is simply a matter of adding a few questions to determine the literacy and resilience of your clients.

For those that want to take it a step further, a gap analysis of one’s current service offering against these segments is a good idea.

To do this, you will need to analyse all your existing clients who now have the new segment data and then ask yourself, “Do I offer an appropriate service model for these target segments?”

If so, this is indeed positive. If not, perhaps it is time to innovate and come up with a new investment offer for the underserviced segment(s). Alternatively, it might be time to remove a particular segment from your database entirely.

Plotting one’s customer base

Knowing clients better

To plot one’s customer base, firstly add two fields of “resilience” and “financial literacy” to one’s database, and for each field include six options:

1. Very low

2. Low

3. Average

4. High

5. Very high

6. Do not know.

Then for every record in the database, add values to these new fields. For top clients, this should be relatively easy, as one probably understand them well.

However, for low-touch clients and new prospects, one will need to survey them, either via the fact-find itself or via an online survey (using a tool such as Survey Monkey).

In the fact-find or online survey, a small number of questions need to be asked so as to clearly identify which segment the person falls into.

Tip


July 2016 • 12

As a reminder, financial literacy is the ability to understand financial products and structures and determine an appropriate solution for one’s personal circumstances.

Determining financial literacy

To determine someone’s financial literacy, one needs to ascertain their level of product knowledge and how they apply that knowledge to their own circumstances.

Objective questions will need to be asked to determine their actual knowledge. Questions such as, “How would you describe your financial knowledge on a five point scale?” are pointless as they are entirely subjective.

Questions to be used for objective analysis could include:

1. Have you spent time trying to understand the different financial products available?

2. What are your views on diversification? Do you have a preferred asset allocation (and why)?

3. Do you have a preference between active or passive management? ETFs or shares? Why?

Once this is understood, resilience needs to be considered. As a reminder, resilience is the ability to set long-term goals in the face of possible short-term failure.

Understanding a person’s resilience is slightly harder than gauging financial literacy, as resilience is a state of mind.

Often, resilience is described as optimism, having a good level of awareness and being adaptable. Thus, the types of questions that need to be asked must identify a person’s ability to set goals, their general approach to life and, more importantly, how comfortable they are with setbacks, rejections and failure.

A person with investment experience will be able to relate to investment experiences, so meaningful questions could include:

What financial goals have you set, and how have you achieved them?

How did you behave during the GFC?

Taking account of client experiences outside the financial realm

However, those with limited investment experience will need to look to their business life or their personal interests for indicators. Someone who is a business leader or has climbed Mt Everest probably has high resilience.

Consider

For example

For example


July 2016 • 13

A good question to ask might be, “Do you regularly set goals and achieve them? What are some instances?”

Gap analysis

Ascertaining personality types in a client database

Once the resilience and financial literacy levels for each of the clients in one’s database have been determined and each has been tagged as one of the four resilience/financial literacy segments, it will be easy to identify which of these new segments is the largest and/or most relevant to your business.

Is one’s database made up of Aspirers, Explorers, Disengaged or Mavericks?

To ascertain this, it is necessary to aggregate every record for each segment and then for each segment determine:

1. The number of clients in it

2. Total funds under management

3. Average number of years they have been a client

4. The average age (which may guide the appropriateness of an internet/technology-based solution, or not).

Determining which clients are the most valuable

This analysis will help determine which segment(s) in one’s database is currently the most important.

One should then review their current offer against the types of solutions outlined in this article and ask oneself:

Is this the segment one is most interested in? If not, why?

Is one’s current offer appropriate to one’s ideal segment? If not, how can it be evolved over time?

This type of analysis can be the starting point for vigorous debate and will hopefully uncover many interesting business ideas, tactics and strategies.

If one is true to a customer-first business strategy, this process should continue every year, ensuring one’s offer is continually evolving to meet the needs of one’s customer base.

Conclusion Is it time to discard the risk profile? The answer to this question is “no”. However, a model/technique such as resilience and financial literacy profiling provides a much-needed extension to the risk profile in its current form. Moreover, resilience and financial literacy profiling is not a replacement, but an enhancement.

The four client categories discussed in this article can be easily incorporated into a financial advice business, help provide a better understanding of clients’ education, communication, engagement and investment needs and effectively address some of the gaps identified in the risk profiling process.

For example


July 2016 • 14

Disclaimer: This information has been prepared and issued by netwealth Investments Limited (netwealth), ABN 85 090 569 109, AFSL 230975. It contains factual information and general financial product advice only and has been prepared without taking into account the objectives, financial situation or needs of any individual. The information provided is not intended to be a substitute for professional financial product advice and you should determine its appropriateness having regard to you or your client’s particular circumstances. The relevant disclosure document should be obtained from netwealth and considered before deciding whether to acquire, dispose of, or to continue to hold, an investment in any netwealth product. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including netwealth, or any other member of the netwealth group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information.

* lnvestmentTrends 2015

To give advice on the product(s) referred to in this article you must be licensed or accredited by your licensee and operating in accordance with the terms of your/their licence. Kaplan Professional recommends consulting a tax adviser on matters relating to tax advice and a legal professional for legal advice.

DISCLAIMER This document was prepared by and for Kaplan Education Pty Limited ABN 54 089 002 371. It contains information of a general nature only and is not intended to be used as advice on specific issues. Opinions expressed are subject to change. The information contained in this document is gathered from sources deemed reliable, and we have taken every care in preparing the document. We do not guarantee the document’s accuracy or completeness and Kaplan Education Pty Limited disclaims responsibility for any errors or omissions. Information contained in this document may not be used or reproduced without the written consent of Kaplan Education Pty Limited.

Reconfiguring the risk profile - My Kaplan...Reconfiguring the risk profile July 2016 • 5...

Documents

Transcript of Reconfiguring the risk profile - My Kaplan...Reconfiguring the risk profile July 2016 • 5...