Abstract

Client risk tolerance is universally assessed in the advisory process to help financial advisers provide suitable advice that assists clients in their investment decision-making. Although there is a well-established literature on risk tolerance and decision-making, little is known about financial risk tolerance and its influence on investor decisions in the financial advice context. Thus, the purpose of this study is to examine this influence with a focus on the key expected risk tolerance determinants: client financial literacy, trust in the financial advice service, and relationship length with the service. A new theoretical model and related hypotheses were proposed and tested using survey data from financial adviser clients in Australia (N=538). Results revealed a positive relationship between client risk tolerance and investment decision-making. Further, client trust and relationship length with the service were found to be positively associated with client financial literacy and risk tolerance. These findings, which provide a more comprehensive understanding of how risk tolerance and its antecedents influence client decisions, have the potential to improve advice in the financial services industry.

Introduction

According to a new industry research report: Global Wealth Management Market 2015-2019, the global wealth management market is expected to grow significantly at a compound annual growth rate of 10 percent by 2019. Indeed, provided the recovery of the world economy, a large portion of the baby boomer generation approaching their retirement, and an increasingly complex investment environment, financial advisers/planners are playing an important role in helping individuals around the world with their investment decisions. As a consequence, instances of poor advice are also likely to be increasingly costly. For instance, recent collapses of large Australian financial advisory firms such as Storm Financial and Opes Prime provide an early warning of the costs of such poor advice. The consequential criticism of the integrity of the financial advice industry, led the Australian government to enact the Future of Financial Advice (FOFA) reform regulations (effective from 1 July 2013). The reforms introduced a statutory requirement for financial advisers to act in the best interest of their clients. Clearly advisers cannot do this without understanding their client risk profiles, including their financial risk tolerance which refers to ‘the maximum amount of uncertainty someone is willing to accept when making a financial decision’ (Grable 2000, p. 625). As emphasized in Gibson, Michayluk, and Van de Venter (2013, p. 42): ‘It is vital that financial advisors understand the effect that their services have on the financial risk tolerance of potential clients’.