Undoubtedly, one of the most important skills a financial planner can have is the ability to correctly ascertain a client’s financial risk tolerance. It wouldn’t be an overstatement to say that an advisor’s ability to do this is fundamental to judging their overall job performance and their overall effect as an advisor. With that said, determining a client’s true financial risk tolerance (versus, for example, what the client feels is his or her financial risk tolerance) is oftentimes not a simple or straightforward thing.
A client’s true appetite for risk,as opposed to what they believe their appetite for risk is,can sometimes be dramatically different, and in order to be an effective financial planner, it’s crucial to be able to determine where the distinction lies.
1. Understand the client outside of their financial portfolio
In order to truly understand a client’s financial needs, and in turn, understand their tolerance for risk, it’s important to know some things about the client outside of their financial portfolio. For example, where is the client in their path in life? Are they approaching retirement? Are they new to investing their assets? Do they have any particular goals in the short-term or long-term that they’re looking to achieve?
The answers to client profile questions such as these play an important, and indeed irreplaceable, role in giving a financial planner a clearer, better-rounded view of a client’s financial needs. Therefore, equipped with answers to these sorts of questions, a financial planner can more accurately determine a client’s tolerance for risk, and arguably more importantly, can determine where the distinction lies between a client’s true appetite for risk and the client’s belief of the same.
2. Understand the client’s short-term and long-term financial objectives
Along similar lines as point 1 above, it’s incredibly important for a financial advisor to know as much as possible about a client’s financial goals, both short-term and long-term. For example, think how much the goal of buying a home plays into a client’s financial makeup. Now consider a client who has a goal of buying a new home in say a year or two versus a client who has a goal of buying a home in say ten years. Obviously,this difference would signify to a financial planner like myself, Jack Comeau,to approach the two clients in twoentirely different ways. Which serves as just one of many examples for why it’s critical for an advisor to have some idea of their client’s primary financial objectives.
3. Gain an understanding of what kind of financial tools the clienthas used in the past
Another intelligent way to decipher where a client’s risk tolerance lies is to see how he or she has invested in the past. Did the client prefer to invest heavily in stocks in the past? Did they take a more conservative approach? Was diversity a key element in their past investment pattern, as opposed to say more aggressive, one-avenue investing? Gaining an understanding of how a client invested prior to that client’s affiliation with a financial planner does two things – one, it provides the advisor a more complete look at the client’s financial picture; second, it gives the financial planner a better idea of the client’s risk appetite, free of the client’s beliefs and opinions.
4. Communication with the client is essential
It should go without saying that an advisor has the responsibility of conducting in-depth conversations with their client about the client’s financial needs and the details of their portfolio. This is something that’s imperative for the success of the financial advisor-client relationship; and, furthermore, these kinds of conversations should be conducted on a periodic, if not regular, basis. One of the main purposes of these kind of briefings is to give the advisor and the client a prime opportunity to discuss in detail the client’s risk tolerance and, hopefully, to come to an agreement on the same. Indeed, I would argue that these briefings are so critical that without them, an advisor’s understanding of a client’s true risk tolerance is seriously jeopardized.