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Investing some money? Don’t rely on risk quizzes

Filling out multiple choice risk quiz

A risk quiz can be a handy way to kick off a conversation about what you might want from your investments. But don’t let it define where you put all your money – you could end up taking on more risk than you thought.

One of the principle tenets of investment is that if you take on more risk, you increase your potential for higher returns. Yet in the same stroke, you’re pushing up the chances that you could lose some, or all, of your money.

With interest rates so low and inflation now biting at 3.7%, many of us are turning to investments just to maintain the value of our money. But how do we know how much risk we should be taking – and what methods are people using to understand their attitude to investment risk?

Watch out for the risk quizzes

If you go to get investment advice from a bank (don’t do it), an insurance company or an independent financial adviser, chances are the first thing you’ll be given is a quiz to assess your attitude to risk. The results of these are usually used in order to recommend investments to you.

But in a perverse twist of irony, you could be taking on more risk with your money just by being prudent and filling out a risk quiz in the first place. A report published last week by the Financial Services Authority (FSA) has slammed many of the risk questionnaires that advisers are using to help you decide where to invest your money.

Poor question and answer options, over-sensitive scoring and inappropriate weighting to answers have led to people getting inappropriate interpretations of the outcomes, the report found. In other words, people have ended up with the wrong investments off the back of these quizzes.

Don’t get pigeonholed

The FSA has timed this damning study perfectly. Yesterday, it announced that Barclays would be receiving a record £7.7m fine and forced to repay up to £59m in compensation to its customers, after it inappropriately recommended that they invest in a ‘cautious’ and ‘balanced’ fund, neither of which were suited to thousands of its customers’ needs.

Apparently, the bank’s staff had not been spelling out the risks of the funds – only the benefits. They carried out such basic assessments of their customers’ investment requirements that they just plonked them into two funds, pigeonholing them as either cautious investors or balanced investors.

The reality is, terms like ‘cautious’ or ‘balanced’ mean totally different things to you, to your bank and to a fund manager running an investment. By investing in a fund that’s called cautious, for example, all that’s happening is that your attitude to risk is being scrunched up to fit somebody else’s product.

And when it comes to investment and introducing the risk of loss to your cash, especially in this economic environment, it’s vital that your choices are suited to you, not just what fits with your bank or adviser.