Are risk profiles still fit for modern financial planning? From risk profiles to real outcomes.

The financial planning profession is evolving, and the advisers we speak to increasingly feel that conversations with clients are evolving too.

Financial advice is moving beyond risk profiling as a means of finding a suitable investment solution. Instead, the focus is shifting towards discussions about goals, time horizons and client objectives.

The context

If you were to skydive without a parachute, would you say that it is risky?

Technically, it isn’t, as the outcome is relatively certain.

Investment risk can be thought of in a similar way. At a high level, investment risk reflects uncertainty of outcomes – typically, the greater the variability of those outcomes (e.g., with equity investing) the higher the risk.

A goals-based investing approach encourages professionals and clients alike to think about what clients want to do with their money and when, and allocate their capital accordingly. More stable, liquid investments may be suited to shorter-term goals, whilst longer-term goals can afford more volatility along the investment term, deeming asset classes further up the risk scale potentially more appropriate.

In practice

As an example, let’s consider £500,000 of investable wealth for a client – Rusty – with a medium appetite for risk.

Under a traditional risk-profiling approach, Rusty might be assigned a score of 5/10, leading to the selection of a corresponding risk-rated portfolio, reviewed annually.

A goals-based approach, however, starts with what Rusty is trying to achieve and when.

Perhaps Rusty would like to buy a home in the next three years. This portion of capital (or bucket) therefore needs to be protected – cash, shorter-dated fixed income investments and money market funds may be suitable here.

Next, Rusty is hoping to fund education fees which are due in the coming seven years. We need to be mindful of preserving capital, but we also must select assets that have growth capacity, so the medium-term bucket can keep pace with price rises over time.

Rusty is thinking about retirement, too, but this is 20 years away. This particular bucket can be exposed to more investment risk – volatility during the investment term could be more acceptable here as there is more time for down periods to recover.

Comparison

Both goals-based investing and risk profiling have their benefits, but they also have their drawbacks.

Risk Profiling:
· Helps identify a suitable level of investment risk
· Supports advice and decision-making
· Creates a clear starting point

But…
· Questionnaires can oversimplify circumstances
· Multiple goals and time horizons can be merged into one score
· Can produce inconsistent results which can depend on the questions asked
· May overweight attitude to risk while underweighting:
· Capacity for loss
· Investment time horizon(s)
· Behaviour during market downturns

Whilst goals-based investing:
· Makes investing personal and relevant
· Helps prioritise multiple objectives with varying time horizons
· Encourages investment discipline in market downturns

But…
· Goals can change over time
· Multiple goals can add complexity
· Unrealistic goals may require a broader conversation

What does the FCA say?

Firms should avoid “shoehorning” clients into portfolios based on risk scores alone. Suitability should be driven by client objectives, not just alignment to a risk category.

The optimal solution for the profession is likely somewhere in between – recognising the value of risk questionnaire outputs, whilst allowing for flexibility to cater for a range of client objectives: a client’s attitude to risk can differ depending on what the money is being used for and in what timeframe.

The Bottom Line

Ultimately, financial planners need a structured framework and a robust toolkit to support more meaningful, goal-focused client conversations.

At Aspen, we’re continuing to work alongside advisers to support this shift – combining investment expertise with a comprehensive suite of portfolios and best-in-class technology to help bring goals-based investing to life in client conversations.