One of the most important steps in constructing a portfolio is figuring out a client’s true risk tolerance.
That isn’t always easy, because often clients don’t really understand their own attitudes toward risk.
“You have to really drill down to figure it out,” says CFP Jane Newton.
She takes clients’ descriptions of themselves as “aggressive” or “conservative” with a grain of salt.
“I don’t like those labels. They mean very different things to different people,” says Newton, managing partner and wealth adviser at RegentAtlantic Capital in Morristown, N.J.
It is important to ask lots of questions and then present the client with easily comprehensible projections and models based on the answers, she says.
When clients first come to Newton, she wants to know how they make investment decisions: Are they making the decisions themselves or leaving them to a broker? And how do they keep up with information about their portfolio?
The most reliable client attitudes toward risk often emerge from the one question: How did you behave during the 2008 market crash?
“Riding that roller coaster for many of them was the first time they figured out what their real risk tolerance was,” Newton says.
How those clients responded then and how they feel about it now gives her a measure of their true investment outlook.
Sometimes client questions can tell advisers a lot about risk tolerance, says Maria Cornelius, a CFP and the executive vice president of Burt Wealth Advisors in Rockville, Md.
“One way you can tell that a client is not a high-risk investor is if they’re calling you fearfully every time different things happen in the markets,” she says.
In order to get a handle on client fear and risk tolerance from the get-go, Christopher Cordaro, a CFP and colleague of Newton’s, says he often uses a variation on the “old broker’s trick” of always reporting gains in dollars and losses in percentages.
“Brokers always like to say, ‘You’re up $100,000,” says Cordaro, managing partner, chief investment officer and wealth adviser at RegentAtlantic Capital.
“Who knows what that was in percentage terms?” he says. “It might be half of what the market did, but you feel good when you hear you made $100,000.”
Cordaro says he flips the example around when he wants to get an idea of a client’s risk tolerance.
“If you have $2 million and you just lost 25% of your portfolio, your $2 million just went down to $1.5 million; you lost $500,000,” he suggests as a possible scenario to clients.
“How are you feeling about that? Once you start asking enough questions and putting it in dollar terms, you can see whether they’re getting visibly uncomfortable, or whether they say, ‘OK, I’m fine with that,” Cordaro says.
This story is part of a 30-30 series on ways to build a better portfolio.