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Understanding investment risk and risk appetite

With interest rates remaining close to historic lows, with the recent weakness in global equity markets and with even the UK property market becoming subdued the issue of where to invest for a good return - and for a return that is fair for the risks involved - has come to the fore again.

One issue that those advising investors have to grapple with is the lack of clarity that people have about the nature of risks associated with different investments and the genuine appetite they have for taking on those risks in the search for higher returns.

With this in mind I thought it timely to repeat the blog published by my former colleague Sharon Collard in 2015. The blog highlights some of the isues around the understanding of risk and provides a link to the research paper compiled on this key issue for investors and those advising them

Martin Upton

Director, True Potential PUFin

10th April 2018

True Potential PUFin research finds that misconceptions about risk are undermining pension planning

Like previous studies, our recent research, ‘Towards a Common Understanding of Risk’, finds that the UK public generally has a fairly basic understanding of the risks of saving and investing. But our research also exposes the great variety of factors that affect people’s perceptions of risk and their investment decisions. In an advisory process, some or all of these factors may be taken into account in the discussion between adviser and client. But what about the growing numbers of people who elect to make their own investment decisions? How can the industry and the regulator ensure that ordinary people make sound decisions, and steer clear of investment frauds and scams in their search for better returns at a time when savings interest rates remain historically low?

Our research suggests that no one tool or questionnaire can provide the answer. What is needed instead is a toolkit for the ordinary investor, to help people get to grips with the sorts of things they should understand and the questions they should ask (of themselves and others). The toolkit is not intended to replicate the advisory process, nor is it simply about giving people more information. Rather, it’s about helping people make better use of the information and resources that are already available, by giving them some idea of the things they should think about in order to make sound investments.

To develop a practical, effective toolkit that people actually use requires input not only from experts but also from the ordinary investors that it’s aimed at. As the psychologist Paul Slovic concluded almost thirty years ago in relation to risk perception in everyday life: ‘… risk communication and risk management efforts are destined to fail unless they are structured as a two-way process. Each side, expert and public, has something valid to contribute. Each side must respect the insights and intelligence of the other.’[1] Going forward, we plan to explore ways to put this research into action, in partnership with industry stakeholders

An important part of that toolkit would be a new generation of Attitude to Risk Questionnaires designed specifically around the needs of ordinary DIY investors, particularly those new to investing. This new generation of Questionnaires would (1) take some account of individual circumstances and objectives (2) help people think about the different dimensions of ‘risk capacity’ and (3) be consumer-centric and user-friendly.

Sharon Collard, Professor of Personal Finance Capability

6 March 2015

About True Potential PUFin

True Potential PUFin is based at the Open University Business School in Milton Keynes, UK

True Potential PUFin is the first and only personal finance research centre in the UK that has an active teaching programme freely available to the public. Supported by the University’s excellence in delivering distance learning, the Centre is uniquely positioned to develop the public’s financial capability and to research the impact and effectiveness of its education programme.

True Potential PUFin is supported by a five-year programme of financial support provided by True Potential LLP.

The views of True Potential PUFin academics do not necessarily reflect the views of True Potential LLP

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