People advising on finance are supposed to “know the customer”. They should find out your goals, what your attitude to risk is and so on. That may be tricky, since you probably don’t know what your values and goals are yourself (unless you’ve spent a lot of time on this site!) so how are they going to find out? And if neither of you know exactly what you want, when you want it and what you’re prepared to do to get it, how can they work out your “attitude to risk”?
But they are supposed to “know” you, so they may give you an, “attitude to risk” questionnaire. That will allow them, in theory, to categorise you as a “cautious” or “aggressive” investor and various other descriptions. Once you’re in categories of “risk profile”, the theory says, the advisor can steer you towards an investment that is “appropriate” to your “risk profile”.
You might know about framing effects – the classic example being a game show where you are offered choices. Imagine, instead of a game show you are talking to your stockbroker, financial advisor or bank manager. You want some information about an investment.
Even if you know what risks you are prepared to take, the way they phrase their questions (or the ones in their questionnaire) about risks will affect your answers. For example, if they say – “this is 50% likely to gain you money over 3 years” – you’ll have a different reaction to whether that is acceptable to you than if they said – “this is 50% likely to lose you money over 3 years”.
Both of them are logically the same, but you’ll come out as a “different” risk profile depending on how they ask the question.
Unless advisors actually know what is going on psychologically, as well as financially, it’s hard to see how they are going to be able to give you the best advice.
Of course, you can hope that the regulators will actually understand this and make sure the psychology is included in the training for Financial Advisors. Bearing in mind the pensions mis-selling, endowment scandals and all the other problems that went on for years before the regulators realised the problem that was going to happen because of their inadequate rules, how much of a gamble do you want to take on the regulators keeping you safe?
