Market volatility in recent years has made it especially important to have frank discussions with all of your clients about risk tolerance, says Alan Middleton, executive director with the Schulich Executive Education Centre at York University in Toronto.
“What one client might see as a risk,” Middleton says, “another could see as an opportunity.”
With that in mind, Middleton says, it is your role to show your clients, in the most concrete way possible, how the level of risk in their portfolio can influence their financial future.
Middleton offers the following tips to help you prepare for the “risk” conversation:
> Start with the basics
As a general rule, Middleton says, you can rely on some basic trends, such as age and asset levels, as a guide to your clients’ position on the risk scale.
Risk tolerance generally decreases with age; younger clients have more time to make up any short-term losses and, therefore, can take on more risk. Similarly, clients typically become more conservative as they approach retirement.
There also is a correlation, Middleton says, between a client’s total assets and his or her tolerance to risk. Clients with higher asset levels are generally more risk-tolerant as they seek higher yields. Clients with lower assets, on the other hand, are usually more vulnerable to losses and therefore less tolerant to risk.
> Ask the right questions
Depending on the type of relationship you have with your client, Middleton says, your discussion about risk can be either a subtle or a blunt process.
Often, the most direct way of decoding a client’s threshold for risk is to ask: “How much money are you willing to lose?”
It’s all part of understanding what your clients are prepared to trade off for the chance to make gains.
Clearly, no advisor wants clients to lose money. If, however, your client is not worried by the thought of losing 25% of his or her portfolio for the opportunity to make a 50% return, there’s a good chance this client has a higher risk tolerance than the client who begins to hyperventilate at the thought of losing 2% of their investment, regardless of the potential return.
“It comes back to the old golden rule,” Middleton says. “Get to know what your clients want and hope to do.”
> Meet both spouses
Before determining a particular client’s risk tolerance, evaluate the overall dynamics of the client family — in particular, which member of the family you see as the “influencer.”
For example, if you meet only with the liberal-minded man in a more conservative matriarchal family unit, you likely won’t get a good gauge of that household’s overall risk tolerance. So, you should have both spouses come in for client meetings whenever possible.
> Know your own biases
In theory, you provide objective advice to your clients. But as a human being, Middleton says, you are bound to have biases of your own.
To help you identify and understand those biases, Middleton suggests trying a leadership assessment test, such as those provided by Kolbe Corp., or others that are available online.
Taking this kind of tests will give you some feedback about whether you are, by nature, a risk-taker or a more conservative investor. This knowledge, combined with awareness of your own attitude toward money, can help you provide more objective advice to your clients.