Aclient’s risk profile is similar in some ways to a blood pressure reading. An accurate reading by itself does not determine diagnosis or treatment, but provides critical information to medical experts who can then determine a course of action.

Similarly, according to FinaMetrica Pty. Ltd., the Sydney, Australia-based developers of FinaMetrica Risk Profiling System software, a client’s risk profile serves as a guide to implementing an asset-allocation strategy, but does not necessarily determine the appropriate asset mix.

FinaMetrica’s Risk Profiling System, although questionnaire-based like most risk-assessment software used by financial advisors, provides a scientific assessment of an individual’s personal financial risk tolerance using psychometrics to ensure validity and reliability.

Psychometrics is the field of study associated with psychological measurement, including knowledge, abilities, attitudes and personality traits. It involves the construction of instruments and procedures for measurement, and the development and refinement of theoretical approaches to measurement. In the case of FinaMetrica’s software, this is a risk-profiling questionnaire.

Launched in 1998, FinaMetrica’s Risk Profiling System was developed and tested in Australia over four years with the assistance of the applied psychology unit at the University of New South Wales. Currently, it is used by financial advisors in eight countries; it was launched in Canada in May.

FinaMetrica says it is the world’s first Web-based system to meet internationally accepted psychometric standards. Although advisors can acquire the software from FinaMetrica, it is also part of an integrated financial planning software package offered to advisors by PlanPlus Inc. of Lindsay, Ont.

Geoff Davey, co-founder and CEO of FinaMetrica, says a typical risk-profiling questionnaire asks investors about 10 questions relating to age, investment objectives and experience, risk aversion and time horizon. The answers result in a score that is then associated with an asset mix, which in most instances is not unique to the client’s risk profile. According to Davey, most questionnaires ask situational questions that do not assess risk tolerance appropriately. For instance, questions dealing with how much risk a client can afford to take, time horizon and goals are not part of the risk tolerance construct, even though they are important to the financial planning process. Davey contends commonly used risk-tolerance questionnaires are actually “asset-allocation calculators.”

FinaMetrica’s risk-profiling questionnaire asks 25 questions and takes about 15 to 20 minutes to complete. Typical questions about investment objectives, goals and time horizon are not included. Rather, the focus is on personal experiences, knowledge, attitudes and behaviour in specific situations.

The questions are clear and easy to understand, but require above-average investment knowledge. Upon completion of the questionnaire, a personal financial risk profile can be downloaded immediately. Based on the score obtained, the client is ranked in one of seven risk groups. Any variations in answers relative to risk group assigned are italicized, indicating the need for further discussion with the client.

Once the client completes the questionnaire, which can be done online in his or her own time, the advisor can proceed with selecting a portfolio that is consistent with the relevant risk score.

To assist advisors with this process, FinaMetrica provides advisors with a comprehensive Investment Risk and Return Guide, which can be used to educate clients and help advisors manage their clients’ expectations. The guide uses historical data for illustrative and analytical purposes for each of the seven risk groups.

“FinaMetrica does not provide asset-allocation recommendations,” says Davey. “It allows you to evaluate what you would otherwise recommend and identify any existing gaps.” The software allows advisors to come up with “a best fit range,” he adds. The company’s Web site also provides detailed guides to assist advisors in using and applying the software to their practices.

FinaMetrica recognizes that people generally do not accurately estimate their own risk tolerance. Answers to the same question may vary over time and in different situations. Therein lies the weakness in any risk-tolerance questionnaire. IE