How to understand risk tolerance

The FSA's Guidance Note on establishing a customer's risk tolerance and the suitability of recommendations identified a number of serious shortcomings in the processes of many advisers.

While the FSA’s analysis was generally good, it was short on practical suggestions, leaving the “difficult stuff” for financial advice businesses to work out for themselves. There are several key steps in a robust process for understanding a client’s tolerance to investment risk. 1. Psychometric risk profiling A good psychometric risk profile questionnaire gives a statistically reliable profile of an investor’s attitude to risks in general, rather than to specific risks such as: capital loss; failure to meet a desired investment objective, such as repaying a mortgage; los...