Many of us use a traditional risk tolerance questionnaire. We use this questionnaire in an effort to protect clients (and our firms) from too much, as well as not enough risk, depending on the situation. But using a simple risk tolerance questionnaire has its challenges.
Not only do many of these questionnaires take an age-based approach to risk capacity (which may not be appropriate), they rarely have the ability to view separate “buckets” of money independently, which is how many clients view their investments. In addition, these questionnaires typically focus exclusively on investments. But, investments are only a piece of the client’s financial situation.
Another major, often overlooked issue with risk tolerance analysis is a lack of true training, which leads to many advisors simply going through the motions.
While this pads the client file, it rarely adds value to the client experience. The most glaring problem with current risk tolerance questionnaires is its failure to add any perspective and context to what the risk score means. To better understand how we can use technology to improve the client experience and add perspective, we have to understand what we are measuring.
In general, when an advisor uses a risk tolerance questionnaire, it is to assess a client or prospect’s appetite for risk. This is a very myopic approach to measuring one's appetite for risk within the context of their financial life. Clients need to understand the impact and implications of a given level of risk on their financial goals over their entire lifetime. In other words, are we measuring risk tolerance only to provide comfort with short-term volatility, or are we taking into consideration their ability to fund their lifestyle twenty years from now?
As advisors, we need to view the process of assessing risk tolerance to that of a doctor assessing a patient’s heartbeat or other vitals. As it stands today, most advisors present a portfolio based on a risk tolerance questionnaire and tell clients that, over the long-term, they will be just fine. Very little – if any – attention is paid to how the portfolio will perform with a given level of risk under different circumstances. We need to measure investment risk throughout a client’s whole financial life. We can then embrace technology to provide context and perspective as to what this means in different scenarios. From there, we have a much better idea of a client’s true risk tolerance.
We’ve seen digital advisors with very impressive technology. While the technology makes it easy for people to open accounts, it may sacrifice the emphasis on risk assessment. The goal of technology shouldn’t be to simply expedite account opening and implementing an investment plan, but to provide clients and advisors tools that add perspective to their risk tolerance across their entire financial life.
In recent years, new risk tolerance technology has come forward to aid advisors and their clients. The technology simulates how a portfolio may react in certain markets. Advisors can leverage this technology with their clients as part of a comprehensive review. This can help from two perspectives: First, a client’s situation can change over time and this technology can add perspective and keep clients engaged. When clients are engaged and grasp the context – or the why – they are much more likely to stick with their plans.
The other benefit is helping clients avoid comparing their performance to benchmarks that may not be relevant to them. For example, in up and down markets clients may question their performance relative to the S&P 500, wondering why their investment performance does not have the same return. Most advisors today might discuss the benefits or diversification (as they should) but leveraging technology, as part of a client review meeting, to simulate a variety of outcomes can be very helpful.
Technology in the financial world is developing rapidly. Clients and advisors will be better served by leveraging a variety of the new technology that has been brought to market over the past few years. It’s also important to recognize that technology can’t replicate many aspects of the business that need to be completed by a human.
Technology will continue to evolve and help advisors and clients define and manage overall risk in all of the pertinent areas of wealth management. We can better understand the client by defining what risk means to them. At the end of the day, it’s about understanding the client and providing the right resources and advice.