Matching clients’ investments to their risk tolerance levels is increasingly becom-ing an important part of financial planning. Jason Spits explains why.
Matching clients’ investments to their risk tolerance levels is increasingly becom-ing an important part of financial planning. Jason Spits explains why.
Most people who have watched daredevil sporting championships — with events like downhill skiing on 70 degree slopes – have probably said they would never do anything like that themselves.
At times, many clients can be forgiven for feeling the same nail biting anxiety when they watch where markets move.
Some might later feel that they would never have in something like that had they known what it actually entailed. And, they might be tempted to compare the plan-ners who put them there to the cowboys on the ski slopes.
The problem, it seems, is that their planners may not have bothered to assess their risk tolerance. And, in not doing so, the planners have increased their own risks.
If things go wrong with the markets, for example, the planner could face a barrage of complaints from distressed clients, a flood of customer departures, or possibly even legal action.
Argyle Partnership senior partner Peter Bobbin says while many planners have misunderstood risk tolerance, things are changing.
“For some time financial risk was linked to products, but it has now become more important to examine the risk of clients as the whole concept of standards of care and duty change,” he says.
“This has been driven by the increasing sophistication of clients and the industry it-self. It is becoming more common when clients change planners for their new ad-viser to examine their portfolio and recommend legal action if they consider the portfolio badly managed in the past.”
And, Bobbin doesn’t view this trend as a sign of increased negligence in the in-dustry, but rather as one that is normal in a professional environment and a clear sign that the industry is maturing.
ProQuest joint managing director Geoff Davey concurs. “There has been a rise in consumerism with clients becoming better educated and aware of their rights,” he says.
“At the same time, there has been a shift from a commission driven sales industry to one that supplies professional services where we meet needs, and risk tolerance is one of them.”
Money Manager managing director Kevin Bailey attributes the growing emphasis on risk tolerance, in part, to concerns about possible market corrections.
“There has been a focus on selling and past performance. There has also been five years of growth and planners are getting cautious and see the need to cover them-selves,” he says.
According to the experts, the best way for planners to avoid potential problems – and create a fall back position for themselves – is to encourage clients to take a long term view of their investments.
“Negative experiences result as clients misunderstand their risk, what they believed they placed their money into, compared to what they actually did,” Davey says.
“Risk tolerance methods provide a trail of proof. The clients must know what is being provided to them to avoid misunderstandings while it is critical for the ad-viser to get informed consent,” he says.
At its core, risk tolerance is an educational and explanatory process which exam-ines clients’ objectives and goals over a period of time.
Heraud Harrison principal Michael Harrison says the key to success here lies in extracting information from a client who may not know or readily relate that in-formation to a planner.
“We, as planners, have to explain the risk of investing and the possibility of nega-tive returns to our clients. We have to examine the current situation and check if that fits with clients’ needs, or we have to find an alternative,” he says.
“Planners have a responsibility to maximise wealth. Those out to make a dollar and do whatever is most comfortable for clients are not always taking the best ap-proach.”
THP Services compliance manager Michael Rowles says: “Both parties need to look at objectives, assess the risk level and create a balance. If this doesn’t produce a match, reassessment of the objective is necessary, or there can be a change in the time horizon, or the level of risk the client is willing to sustain.”
Harrison says through regular annual reviews the process of clients accepting risk increases and with encouragement, it becomes self sustaining.
“As planners we prompt people to call us and discuss investments from their per-spective. Our aim is to make them responsible for their own money. They have to end up pushing the investment choices but we may also have to tone it down if we believe the choices are wrong,” he says.
The mistake many advisers make, it seems, is to treat risk tolerance as a separate issue instead of one that is core to the very nature of financial planning.
“Risk tolerance is often seen as a bolt on idea as a result of using tools such as questionnaires, but it should be part of an holistic approach instead,” Rowles says.
“Planners have to assess not only risk but the client’s ability to understand the is-sues and meet that with explanations suited to the client,” Rowles says.
Bailey adds: “Every academic assessment of risk is a crock. To call it risk disclo-sure is audacious. It should always be an explanation of risk. Clients need to under-stand risk by seeing how it works via protocols to reach objectives. This is about fifty per cent of my job and the key to success with clients.”
Getting risk tolerance right can prevent relationships with clients from growing sour. It also fosters trust and confidence, referrals and client loyalty and it adds in-creased professionalism to the planner’s business.
“This is important because planners recognise that bad advice hurts the entire in-dustry,” Davey says.
“What the planner ends up with is a long term client with realistic expectations, one who stay for 20 years instead of looking for a quick buck approach,” Bailey says.
“If we get clients to work through these issues they can see there isn’t any witch-craft at work and together we are looking out for their interests.”
