The Financial Services Consumer Panel is calling for a standardised approach to explaining risk to consumers, although advisers expressed scepticism over the practicality of the scheme.
A research paper: ‘Investment Risk Rating – Consumer attitudes towards risk’, carried out by IFF Research on behalf of the FSCP, shows while consumers have a broad understanding of the risk-reward relationship, nearly all of them see risk as one of the key barriers to investing.
Although, the paper admits the research was only commissioned to gain a ‘toe in the water’ appreciation of consumers’ knowledge of risk, and their views on whether a standardised risk scale would be useful to them.
The 51-page research paper, resulting from eight consumer focus groups and four in-depth interviews with IFAs, reveals most consumers misunderstand the nature of risk and believe capital is safe in a low risk investment.
A pyramid scale – which shows the low risk and low reward investments at the bottom, and the higher risk but higher return products at the top – was the preferred choice of both consumers and IFAs to explain risk, although neither group declared it to be perfect.
While it was considered a useful guide, the design was seen to be more complex than other alternatives, and as it lacks any detailed explanation consumers need further explanation and assistance to understand it.
The research adds none of the scales used in the research “adequately addressed consumer confusion”, but while the report suggests there is a broad appetite for a standardised risk scale, it admits it will only be effective if it can improve consumer understanding.
As although consumers reacted positively to the idea of a standard scale, with one respondent claiming “it would help when seeing advisers – they wouldn’t be able to make a sale for themselves”, some respondents argued the scale had to be independent otherwise it could be misleading.
In addition, all of the advisers were sceptical about the idea, in particular over concerns about how practical such a scale would be and whether it would be possible to create a ‘one size fits all’ approach.
One IFA interviewee adds: “I react to the idea with some horror actually...I would worry about one system to fit all...I think you need to adapt things to the individual client, because different people will take different things on board, and the actual product will make a difference as well.”
Advisers also raised potential problems such as trying to find a common language which would be clear and understood by all advisers and consumers, while a standardised risk scale could give consumers a false sense of security and may end up misleading them by making them think they understand more than they actually do.
However, John Howard, chairman of the FSCP, says: “The evidence suggests few consumers do understand the risks, so we believe a practical system of explaining risks which also promotes understanding is a fundamental requirement.”
“With the advent of personal accounts for pensions, which will come with a choice of products, a consistent way of explaining risk and a greater understanding of risk becomes even more important and pressing.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7034 2681 or email [email protected]IFAonline
Slow progress in improving diversity
Share purchase deal with assets of £28m
Came into effect in January
Three examples of compensation rule issues
Buying in baskets