Feelings, Nothing More Than Your Clients’ Feelings (About Risk)


The world has changed. Access to information is both fast and free. Consumers can research products and services more comprehensively than ever before and see unsolicited feedback from other consumers. This has created a culture where the consumer expects (even demands) to be more involved in the decision-making process of the products and services they consume.

For advisors, this means that clients now want to have a greater role in the creation and fulfillment of their financial plans. Gone are the days when clients come into the office, provide financial details, answer a series of questions about their lives and leave it to you to put together a financial plan for them. They want to be involved in the process, understand the decisions being made, make the connection between those decisions and the pursuit of financial success and actively buy into those decisions before the plan is implemented.

There is a huge opportunity for advisors who embrace this phenomenon. The strength and longevity of client relationships can be directly tied back to an advisor’s ability to set appropriate expectations with clients, so it behooves advisors to master that skillset. The key is to adopt a process that facilitates the right conversations with clients. We believe that involvement begins with a discussion about how the client feels about losing money in the market.

Recognize the client’s feelings about the market

The exercise starts with an assessment of the client’s willingness to take risk. This is also known their psychological risk tolerance. The objective is to determine how much downside risk the client is innately comfortable taking. In order to make the experience real, it is helpful to frame the risk by tying it to the potential for loss or drawdown expectations around the client’s actual portfolio value.

It is helpful to work through several real-world scenarios that include what were (until the past decade) fairly typical – and relatively frequent – declines of 5, 10 and 20% to arrive at a firm understanding of what the client is comfortable losing, without capitulating and making impulsive decisions.

This is a critical starting point of a larger discussion, because it provides unclouded insight into how the client feels about losses. As an advisor, this information provides a baseline when establishing client goals and determining the necessary portfolios to meet those goals.

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Use baseline risk to frame goals

The next stages of the discussion center on the client’s individual goals and what needs to be done to successfully achieve those goals over time. This is where you and client discover (together) that they may need to deviate from their psychological risk tolerance in order to make a goal obtainable. A risk-averse client with a small nest egg may have no hope of achieving long-term objectives with an ultra-conservative investment approach. This boils down to separating their ability to take risk from the need to take risk.

Here are two examples illustrating how understanding a client’s psychological risk and applying a goals-based approach can better align their expectations with their plan:

1. For a risk-averse client, work with the client to capture all of the details of the goal.

  • How much money do you want to have at retirement?
  • When will your retirement begin?
  • How old are you now?
  • How much money is devoted toward the goal today?
  • What is your projected savings rate over time?

You can then create a portfolio consistent with the client’s risk tolerance. The results may show that the client will not be able to reach the stated goal with a portfolio as conservative as the client’s risk tolerance implies. This is where you explain the available options:

  • Reduce the amount of money available in retirement
  • Work longer
  • Increased the amount saved yearly
  • Invest in a higher-risk portfolio with a chance of greater drawdown risk, noting that they have a long time horizon and can afford to take on more risk with the portfolio

2. For a client with a low psychological aversion to risk (high risk tolerance), let’s say their goal is to pay for a child’s college tuition. Again, work through the elements of the goal with your client:

  • The amount of money needed to achieve the goal
  • The amount of time available to invest based on the child’s current age
  • How much money is devoted toward the goal today
  • The projected savings rate over time

Again, you put all the information into the planning software and choose a portfolio consistent with the client’s psychological risk tolerance. This time, the client may discover that the goal is well funded and could be accomplished without taking on as much risk. This, again, provides the opportunity to discuss available options:

  • Reduce the amount of money being saved and redirect that to other goals
  • Invest in a lower-risk portfolio to provide more drawdown protection, noting that the client has no reason to take on additional risk, given the current funding status of the goal

In both cases, understanding the client’s psychological risk and using it as a springboard to discuss why it was appropriate to deviate from that risk tolerance facilitates a productive conversation. The client was not a victim of the process. Instead, they’re empowered to make decisions based on their stated goals and what was possible, given the risk and return of the various portfolios available to them.

Benefits of a collaborative process

Truly knowing your clients involves making sure they know you understand not only their financial goals, but also the risk associated with pursuit of those goals and your client’s feelings about those risks. It involves playing back the information the client has provided and acknowledging where deviations from the client’s psychological risk score exist in the planning process. The alignment of expectations and the process of documenting those expectations may lead to longer, stronger client relationships.

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John Frownfelter

John Frownfelter

John Frownfelter is the investments contributor for Practically Speaking and the managing director of investment solutions within the SEI Advisor Network.

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