Risk Profiling [RP] tools have been used for many years in Australia and Canada, countries which are recognised as being sophisticated as regards financial planning. Close to 50% of independent financial advisers in the UK also use them and their use by Financial Brokers is growing rapidly in Ireland.

Risk preference is the subjective tolerance of risk by an investor. Traditionally, Financial Brokers may have assessed this by having a discussion with a potential investor and measured it on a scale of 1 to 10, where 1 is ‘very low risk’ and 10 is ‘very high risk’.

RP tools are very helpful in assessing the risk tolerance of an investor and the broker representative bodies in Ireland now recommend their members to use them where investment risk is a significant element of a financial decision.

In the aftermath of the Sovereign Debt and Banking Crises of 2007 onward, the European Securities and Markets Authority [ESMA] has prescribed a methodology for defining risk for UCITS funds. These are likely to become mandatory for all funds between 2015 -2016. The ESMA rankings are based on standard deviation rankings on an increasing risk scale of 1 – 7, where 1 is ‘very low risk’ and 7 is ‘very high risk’. Computations are based on the volatility of 5-year returns monitored weekly.

RP tools bring significant objectivity to the process of risk assessment because investors can relate to the outcome as presented and agree or disagree with its outcome. RP tools also bring a level of consistency to the process both over time [from one week to the next] and between different advisers. This is highly desirable in the context of recommendations on the suitability of investment products.

RP tools are not a silver bullet and the skill of financial brokers will still be required to make suitable investment recommendations. This is because those designing tools that measure any aspect of human psychology are aware that it is complex and there are many factors at work such as gender, age and education, all of which can affect outcomes.