The problems with volatility-based risk ratings

What the recent FSA Guidance Note on investor risk profiling made clear was that it is useless to spend time assessing a customer's attitude to investment risk unless at least equal attention is given to ensuring the investment recommended matches the customer's risk tolerance.

However, that is easier said than done, because it depends on which of the many investment risks the customer is most worried about. Sadly, the FSA offered little by way of practical suggestions on how to achieve the difficult task of matching an investment to a customer’s requirements and views about investment risk. Faced with this problem, general industry practice has been to assign investment funds to risk buckets based on a measurement of a fund’s short-term volatility. In practice, it is a little like trying to decide on the best means of transport when all you are told about i...