Advisers turn to new tactics for gauging risk

The S&P 500 has gained 48% over the past year, but memories of the market crash are still fresh, forcing many financial advisers to move risk assessment off the back burner and to the center of their playbooks.

After fielding countless calls from scared and angry clients during the downturn, many advisers discovered that they had to do a better job of assessing and explaining investment risk.

Rather than using short questionnaires to gauge risk tolerance, advisers are now having more meetings, asking tougher questions and using new tools to gain a better picture of what their clients can truly stomach. They are also trying to do a better job of preparing clients for any future market shocks.

“A lot of people said they were fine with a 10% loss, but when it actually happened, they were far from fine with it,” said Lyn Dippel, a certified financial planner with Financial Advantage Inc., which manages $260 million in assets. “They realized they had lost two years of spending.”

DIGGING DEEP

Indeed, advisers said, the client conversations they are having and questions that they are asking about risk have drastically changed since the downturn. For example, Tom Casey, principal at Casey Thomas & Associates, conceded that he used to have vague discussions with clients about risk before the crash, but he now digs deep to determine the cash flow and portfolio returns that they will need to meet their financial goals.

“Our focus is much more on having discussions about capital preservation than it once was,” he said. “The questions we asked weren’t as hard-hitting before.”

Likewise, Lon Morton, president and chief executive of Morton Capital Management, a registered investment advisory firm that manages $1 billion in assets, said that he is asking more-specific questions around risk before constructing investment portfolios. “I want to know what would hurt more to them, getting 1 or 2 percentage points less in returns each year or a major loss in one year, which might mean they’ll lose $25,000 in annual income for the rest of their life,” he said.

Advisers say that they are also spending much more face time with clients to discuss risk. For example, after giving clients a risk questionnaire, they are now following up with a meeting that could last a few hours to go over the answers.

“If advisers just do the investment risk tolerance questionnaire and they miss the opportunity to discuss what it means to clients, then all they have is a document for the file, and they’ve missed a [chance] to differentiate themselves,” said Allison Couch, LPL Financial’s senior vice president of business consulting. “It’s more than just a questionnaire.”

In some cases, advisers have also found that it is important to reassess their clients’ risk more than once a year. For instance, Lauren Lindsay, a CFP whose firm, Personal Financial Advisors LLC, manages nearly $90 million in assets, said that any client who wants to make a change in his or her portfolio redoes the risk profile questionnaire.

Many advisers have also changed the tools they use to evaluate risk.

For example, Mr. Morton now gives clients a questionnaire that gives more weight to certain questions. On a scale of zero to 20, clients who answer questions more conservatively are given fewer points, and aggressive answers receive more points.

In one question, investors are asked if they can accept a 20% loss. For investors who say yes, it counts as 20 points.

Previously, if investors said that they could accept only a 5% loss, Mr. Morton counted that as zero points. Now, that answer is scored as minus 20 (or negative 20).

“That answer is important,” Mr. Morton said. “Regardless of what the other answers may have been, if they don’t want to lose more than 5%, this is a very conservative investor.”

Bob Kargenian, president of TABR Capital Management LLC, which manages $160 million in assets, also sought a better way to gauge clients’ tolerance for risk and recently began using FinaMetrica, a sophisticated risk assessment tool. It combines clients’ answers to a risk questionnaire with their accounts on MoneyGuidePro, the planning software system that he uses.

One question asks clients if they have ever invested a large sum of money for the “thrill” of seeing whether it went up or down. Another asks whether investors would want to work at a job in which they were paid strictly in commissions, or a combination of commissions and regular salary, or just a regular salary.

“This sets up future expectations about worst-case scenarios so that when the next bear market arrives, it will not be a surprise,” Mr. Kargenian said.

In addition to testing clients’ risk tolerance more often, John Anderson, head of practice management for the SEI Advisor Network, which manages nearly $30 billion in assets, said that he encourages advisers to test clients’ risk tolerance for different pools of money.

“My risk tolerance on my retirement account is different than my risk for my kids’ 529 plans,” he said. “There are dramatically different needs for different pools of money. I strong suggest a risk [profile] for every portfolio.”

E-mail Lisa Shidler at [email protected].