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Conflicting Attitudes to Risk

By a twist of fate, I found myself involved in a fascinating debate on attitude to risk at a Financial Marketing Club dinner. We had been due to hear about IHT planning from an industry veteran but he was way-laid and, at no-minutes-notice, Newcastle University student Jessica Fox bravely stepped in to talk about psychology and investing, a subject in which she has conducted original research with investment advisers for her dissertation.

It is tempting to blog about Jessica’s attitude to risk in choosing to fill in in front of experienced financial advisers and providers: clearly, she saw it as an opportunity and in so doing neatly dispelled simplistic assumptions about male and female traits. However, Jessica had a twist of her own to focus on. Her research looked at the difference in attitude to risk (tolerance, not capacity) of advisers compared to their clients and how it has varied through the financial crisis. The results of her research are not altogether surprising but the implications of it are challenging indeed.

You can read a summary of the results in Jessica’s own words in a guest blog here. My own briefer, less eloquent summary is that advisers typically had a significantly greater acceptance of risk than clients and were far less prone to change their attitude in response to market gyrations. Clients, by contrast, are highly inclined to buy high, sell low in practice.

This throws up some knotty questions to which I rather doubt we have definitive answers. If you hate open questions and blogs that present no simple conclusion, I’m going to infuriate you.

  1. Do you put yourself through the ATR questionnaires you use with your clients?

  2. Do you periodically re-take the questionnaire to see how your own ATR is changing (or not)?

  3. Is it easier to advise clients with a similar ATR as you?

  4. How do you prevent the difference between your ATR and a client’s influencing your advice?

  5. How do you respond to changes in a client’s ATR when there has been no material change in their circumstances, only in their sentiment?

In our roundtable discussion, various people cited examples of very poor questions in certain ATR tools. While these were lamentable, having a consistent and thorough process and well-designed questions is surely a good thing. But how much should we expect tools like ATR do? Whether now or in future, do we see technology and science handling even the psychological elements of investing and tackling the issues above?

Having alluded to the strong influence of sentiment on markets, I’ll leave you with a final thought:

  1. Will we ever see a fund whose investment strategy is purely driven by an algorithm that quantifies / predicts the dominant mentality of the herd?

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