Financial advisers and wealth managers are hugely inconsistent when it comes to assessing risk, and often make “noisy” errors based on irrelevant factors – such as the weather or when they have last eaten.
This was the conclusion of a survey by Oxford Risk, who are recommending greater use of technology to assess investors’ risk profile.
The survey, where advisers were asked to make recommendations for a series of hypothetical clients, found there were “wildly different” interpretations of their risk tolerance which impacted final recommendations.
Analysis of the study, conducted in partnership with South African firm Momentum Investments and The Financial Planning Institute, found recommendations “were closer to totally random than totally consistent”.
Oxford Risk’s report highlighted the influence of “noise” in the advice process driving these various. “Noisy” errors can be caused by irrelevant factors such as advisers’ current mood, the time since their last meal, or the weather. As a result Oxford Risk is calling for increased use of technology and algorithms to help advisers deliver more consistent support to clients and avoid issues over assessments of risk tolerance and asset allocation.
Once a specific framework for the measurement of risk tolerance, risk capacity and other relevant factors is established it can be run at scale and speed, the report adds. However it adds that algorithms and AI can’t replace the human touch when it comes to building relationships with client that are based on trust.
In the study, adviser characteristics seemed predictive of recommendations, with university-educated advisers making lower risk assessments than average, while married advisers were lower risk than single advisers and those on salaries made higher risk recommendations than those on commission or fees.
Oxford Risk head of behavioural finance Greg B Davies says: “Like the Decision Review System (DRS) used in cricket or the Television Match Official (TMO) in rugby, technology can be employed to greatly increase consistency and accuracy. But in the end when the margins are extremely tight it should be the umpire’s call. So should it be in the world of investment advice.
“Identifying noise isn’t about eradicating inconsistencies. It’s about eradicating unjustifiable ones and evidencing justifiable ones.”