Risk tolerance questionnaires, scores and levels are a big focus right now in retirement income planning. While many of the tools are still rudimentary (e.g., your desire to skydive probably isn't tied to your investment risk tolerance), we do need to gauge the risk tolerance levels of our clients. But why are we doing it?
First, we are doing it to cover ourselves from a regulatory sense. Let's just be honest, we need to do it, so we do it.
Next, we also know we should be personalizing our advice — it's why it is called personal finance. So, there is a belief that a client's risk tolerance level should drive the planning to some degree.
Lastly, the planning, if personalized, should provide the client with greater confidence and allow them to have a better lifestyle. If the client is checking their account daily, stressed about the market and upset all the time because of their investment allocation, that isn't a quality plan.
So, after we gauge that a client is more loss-averse or risk-averse than normal, what do we do?
Probably the biggest thing most advisors and firms do is readjust the client's investment allocation. But this isn't much of a science today. How do you determine if your client should be in a 60-40 stock-bond portfolio as opposed to a 70-30, or even a 30-70?
Perhaps you go back to the client's goals and see what returns they need and what risk level they can take to help achieve these. But this is really going back to goal-based planning and almost ignoring the risk tolerance level. It can be an effective way to hit the client goals, but generally speaking, a client with less risk tolerance and a higher loss aversion should be in a more conservative investment portfolio.
Next, if we are going to lower a client's equity portion of their investment portfolio we will likely be reducing their long-term investment gains. To offset this lower long-term return, we also should try to get the client to save more money. So, a reduction in investment allocation to stocks could coincide with an increase in savings to retirement accounts.
While many people do not correlate their client's risk tolerance to insurance, it should be connected. A client that is more risk-averse will likely see more value in more insurance, including insurance that fully insures the risk as opposed to risk splitting. This means they are likely to want lower deductibles and more insurance. That could be for health, disability, car, life and long-term-care insurance. So, if you can break down your clients by risk aversion, take the time to discuss insurance planning with the ones who are more risk-averse.
Communication is also going to be important. With a more risk-averse client, you should likely communicate with them more frequently. If they are someone who checks their accounts often, consider reaching out after down market days. For those with low risk aversion, you can stick to a more normal routine of communications.
Also, consider what access points the clients have to information. If you have a really risk-averse client, is it beneficial to send them the weekly, daily or monthly investment overview? Or does this just stoke their concerns? You might not want to encourage them to check their investments daily and could even suggest that they delete apps on their phones or easy access points.
Lastly, remember that if you are planning for a married couple, have them do their risk tolerance questionnaires separately. Taking it together could lead to just learning about one spouse, and spouses can have completely different risk levels. As such, when planning for couples you might need to use multiple strategies to help them separately prepare, invest and save for retirement.
Risk assessment is important, but you can use it in a variety of ways and make it more meaningful for your clients. So, reassess how you are using your tools to create a better client experience.
Jamie Hopkins is director of retirement research and vice president of private client services at Carson Group.