risk profiling - lower risk actually = higher risk

Mistermeaner

hi

question regards risk profiling

I understand that a number of investment companies / advisors will work with clients to understand their 'risk profile' and then structure their invetsments accordingly

i.e. someone 'risk adverse' would be put into generally lower volatility products such as bond weighted funds where as someone with a higher risk appetite would be higher in equities etc.

while i get the principle of this is it not somewhat self defeating as over a long term (esp with pensions) regardless of your 'risk tollerance' going bond heavy at age 20, 30 even 40 and 50 is simply lowering your returns and therefore exposing you to greater risks

Isn;t the concept just misplaced?

Reason for asking my company is moving to a new DCpension provider and the new company will be offering a 'risk review' to help people decide on their investments - i see the whole process as somewhat arbitrary and flawed

Appreciate thoughts and comments 


Thanks

Marcon

Mistermeaner said:

hi

question regards risk profiling

I understand that a number of investment companies / advisors will work with clients to understand their 'risk profile' and then structure their invetsments accordingly

i.e. someone 'risk adverse' would be put into generally lower volatility products such as bond weighted funds where as someone with a higher risk appetite would be higher in equities etc.

while i get the principle of this is it not somewhat self defeating as over a long term (esp with pensions) regardless of your 'risk tollerance' going bond heavy at age 20, 30 even 40 and 50 is simply lowering your returns and therefore exposing you to greater risks

Isn;t the concept just misplaced?

Reason for asking my company is moving to a new DCpension provider and the new company will be offering a 'risk review' to help people decide on their investments - i see the whole process as somewhat arbitrary and flawed

Appreciate thoughts and comments 


Thanks

Not it it's used correctly and implemented appropriately by someone who knows what they're doing - although as recent events have shown, like all things, there are no guarantees in this life when it comes to investments!

For most people, preservation of capital is a high priority, especially those with little or no experience when it comes to investing. Too many bail out completely ('pensions are rubbish!') at an early stage if they see a major drop in their fund value - just look at the posts on this site - which is far more damaging than settling for a more middle of the road approach.

Never forget the power of compound interest over the years...

dunstonh

while i get the principle of this is it not somewhat self defeating as over a long term (esp with pensions) regardless of your 'risk tollerance' going bond heavy at age 20, 30 even 40 and 50 is simply lowering your returns and therefore exposing you to greater risks

Timescale is included in the assessment with advisers   The fund weightings will reflect that.      For example, we currently operate with four timescales for each risk profile level.

Isn;t the concept just misplaced?

There is no perfect way to do these things because you have behaviour risk.  It's all very well saying that you should go 100% equity for 40 years but if the person doesn't have the behaviour to accept that level of volatility, then it would be wrong to put them in that.    The risk of the person stopping the pension because it went down and they couldn't handle it is higher than using weightings more appropriate to their behaviour.

Reason for asking my company is moving to a new DCpension provider and the new company will be offering a 'risk review' to help people decide on their investments - i see the whole process as somewhat arbitrary and flawed

It is unlikely that this risk review will be as detailed as an adviser one.   It is more likely to be flow chart style and consequently more basic in its outcome (robo provider style).     It is an irony that the regulator has told advisers for decades that they should not rely on risk profiling answers to decide risk but are quite happy to let robos and basic systems use that method.     However, something is better than nothing.

Nothing says you have to follow their process.     Remember that the average consumer is clueless about these things.   Maybe it is aimed more towards them than you.

DullGreyGuy

Mistermeaner said:

while i get the principle of this is it not somewhat self defeating as over a long term (esp with pensions) regardless of your 'risk tollerance' going bond heavy at age 20, 30 even 40 and 50 is simply lowering your returns and therefore exposing you to greater risks

Isn;t the concept just misplaced?

What risks do you think it exposes you to? 

The principle is that it, in theory, gives you much more certainty of what the pot will stand at in the future. A higher risk investment strategy will give you a much wider spread of potential outcomes which will go above and below the low risk strategy.

Some will be willing to exchange larger gains for certainty and avoiding the risk of large losses. 

Linton

Mistermeaner said:

hi

question regards risk profiling

I understand that a number of investment companies / advisors will work with clients to understand their 'risk profile' and then structure their invetsments accordingly

i.e. someone 'risk adverse' would be put into generally lower volatility products such as bond weighted funds where as someone with a higher risk appetite would be higher in equities etc.

while i get the principle of this is it not somewhat self defeating as over a long term (esp with pensions) regardless of your 'risk tollerance' going bond heavy at age 20, 30 even 40 and 50 is simply lowering your returns and therefore exposing you to greater risks

Isn;t the concept just misplaced?

Reason for asking my company is moving to a new DCpension provider and the new company will be offering a 'risk review' to help people decide on their investments - i see the whole process as somewhat arbitrary and flawed

Appreciate thoughts and comments 


Thanks

For serious investing with money that really matters you should have an objective.  For example accumulate £500K at current prices by the age of 55 to retire early. You can then monitor progress towards that objective. If you are well ahead of plan it does not make sense to risk failure to meet your objective by chasing returns unnecessarily.  The pain of having insufficient money when you want to retire exceeds the pleasure at having excess.

Basing your investment strategy on an objective is not a strait-jacket - you can always change it if circumstances or your attitudes change.  But at least having the objective makes you very aware of the implications of what you are doing.

If your objective is to make the maximum returns possible then you are almost cetainly doomed to failure.  There will always some lucrative investment you missed out on.  The more returns you seek the less likely it is that you will actually make them.

Being cautious is not necessarily a sign of some personality defect but rather  may well be a rational approach to a complex situation.

If you are in your 20s then you have relatively little money invested and plenty of time.  So it makes sense to go for 100% equity.  By the time you reach your 40's say the position is likely to be very different.  Your pension could represent more than 50% of your total assets.  Wealth preservation rises in importance compared with accumulation.

JohnWinder

I have some sympathy with your (OP's) sentiments, but it’s complex beyond me.
If you were explicitly paying for this new unsolicited service, you might want to ask for any evidence to show that the risk profiling they do gives customers a better result.
But someone, the client or the service provider ought to have some way of risk profiling the client so that they get an appropriate portfolio, surely. The way it’s done, with pro-forma questionnaires might sometimes leave something to be desired.
Your dilemma, ‘bonds are less risky but give poorer returns’ gets to the notion of what is risk and what sort of risks are we interested in. Bonds help with volatility risk, but equities used sensibly help with ‘will my returns be high enough in the end?’ risk.
Being all-in equities means you can have some very uncomfortable months during a crash, and no courage or cash (it’s all in equities) to take advantage of the cheap equities and buy up big. Having plenty of bonds in that circumstance means my portfolio is down only half as much as yours, and I’m cashed up (or bonded up) to buy the bargains. Matching client ‘riskiness’ to portfolio riskiness is far from simple since it needs to deal with that sort of situation as well.
With returns unknown, there’s no way to get the match right with certainty, but there’s money in devising questionnaires and coming up with a better approach. Expect people to keep trying.

Universidad

Interesting discussion, and not just a matter for individual investors. This was one of the questions at the heart of massive cuts made to the USS defined benefit pension scheme.

The level of prudence the scheme insisted was necessary to comply with TPR regulations required such confidence in performance over time that the only way to get it was to go gilt heavy.

But this all but guaranteed lower returns, which introduced a deficit in modelling.

So the pension was cut dramatically to keep it sustainable.

And now people are leaving the scheme or the sector in droves.

To "save" it, they had to destroy it.

One of the questions I asked at the time was why the people in charge of making investments for the scheme were earning ten times my salary just to put our money into guaranteed, low yield gilts.

JohnWinder

You’ll have to straighten me out on this if I’ve got it badly wrong, but when you offer a DB pension then it’s incumbent on you to invest with no more risk than you can afford to take, AND THEN top up the shortfall with further contributions by whoever is offering the pension; was it the employers in this case? Did the USS failure have anything to do with that?
PS Not to justify people being overpaid even if they were doing their job well.

dunstonh

JohnWinder said:

You’ll have to straighten me out on this if I’ve got it badly wrong, but when you offer a DB pension then it’s incumbent on you to invest with no more risk than you can afford to take, AND THEN top up the shortfall with further contributions by whoever is offering the pension; was it the employers in this case? Did the USS failure have anything to do with that?
PS Not to justify people being overpaid even if they were doing their job well.

Effectively yes.   Covering liabilities is the primary objective.

The USS hasnt failed.  It just has a running deficit that needs to be addressed.

Pat38493

Mistermeaner said:

hi

question regards risk profiling

I understand that a number of investment companies / advisors will work with clients to understand their 'risk profile' and then structure their invetsments accordingly

i.e. someone 'risk adverse' would be put into generally lower volatility products such as bond weighted funds where as someone with a higher risk appetite would be higher in equities etc.

while i get the principle of this is it not somewhat self defeating as over a long term (esp with pensions) regardless of your 'risk tollerance' going bond heavy at age 20, 30 even 40 and 50 is simply lowering your returns and therefore exposing you to greater risks

Isn;t the concept just misplaced?

Reason for asking my company is moving to a new DCpension provider and the new company will be offering a 'risk review' to help people decide on their investments - i see the whole process as somewhat arbitrary and flawed

Appreciate thoughts and comments 


Thanks

As you can see from perusing these boards, a lot of people tend to get a bit of a panic on if they see their pension fund making precipitous drops in value, so if your pension fund dropped by 40% when you were one year into retirement, can you still stay rational enough to assume that this is still within the parameters of past history that you tested against, and therefore you don't need to take any action?  

Even if you know your strategy is fully rational, if you are the type of person who will lose a lot of sleep when your pension has dropped a lot early in retirement, I guess this is why people need profiling - you might be wealthier in the long run but you might not be happier if you are losing lot of sleep worrying about the recent market crash.

However fundamentally you are not far off - putting too much of your funds into low valatility and low risk investments is likely to end up with you working a lot longer.  

I know a couple of people who are fully aware of all this, but they still keep bringing up how much their fund dropped this year - go figure....

Rationally I suppose you should only start worrying if the markets do things that have never happened before and you were not prepared for in your retirement planning.

Universidad

JohnWinder said:

You’ll have to straighten me out on this if I’ve got it badly wrong, but when you offer a DB pension then it’s incumbent on you to invest with no more risk than you can afford to take, AND THEN top up the shortfall with further contributions by whoever is offering the pension; was it the employers in this case? Did the USS failure have anything to do with that?
PS Not to justify people being overpaid even if they were doing their job well.

Yes... but the debate about how much risk a scheme can afford to take is highly variable.

There was an interpretation of TPR regs that applies to funded schemes, that essentially USS needed to improve the certainty that the scheme could meet its liaibilities.

The thing is, to be absolutely certain about how investments will perform over 40 years is almost impossible. So there will always be a degree of uncertainty.

However, improving certainty of outcomes generally reduces returns.

This act then opens up a deficit in modelling the future of the scheme.

The deficit can be filled by increasing contributions or reducing benefits (both were done).

But that's not the end.

Those changes reduce the value of the scheme, which (in combintation with a view of the scheme as being in financial trouble, since there's a fresh attempt to introduce cuts every couple of years) leads to members opting out or even leaving the sector.

Guess what effect that has on the scheme?

At some point - and I'm not saying the point has been reached - but at some point you can be so "averse to risk" that you damage the scheme so much through prudence that you've essentially sold the whole farm.

The thing is - risk to a business or a fund is not just the risk of financial or asset losses.

It's also the risk of loss of position in the market, and loss of customers, and the risk that you can no longer compete.

Too much prudence is damn risky.

dunstonh said:

The USS hasnt failed.  It just has a running deficit that needs to be addressed.

Last couple of monitoring reports have indicated a surplus, even not accounting for the cuts made in April last year.

That's largely because the last valuation was taken precisely in the dip of the market crash of 2020 (the start of Covid lockdowns), and the resulting deficit was used to justify further cuts to the scheme. 

It certainly hasn't failed overall as a scheme, but I feel like it has failed me. I quite liked working for a University but with the pension cuts and salary supression I couldn't afford to stay.