How to Determine Your Client's Risk Tolerance

December 8, 2020

For clients and financial advisors, understanding risk can be murky. That’s because there’s a certain amount of risk required to meet a client’s financial goals, yet this often conflicts with a client’s tolerance — how much risk are they willing to take — and their capacity, or how much risk they can afford to take.

To help you juggle these components of risk in a way that maximizes the benefits for your client, we’ve compiled the following four tips.

1. Ask Questions

Because there are environmental, experiential and psychological factors that influence your client’s risk tolerance, it’s key that you explore all facets of a client’s life. How do you do this? Simple. You get to know them.

Ask questions that delve into aspects of their work and home situations, as well as past experiences that might reflect their comfort with risk. For example:

How do they define risk?
Are they married? Does their spouse share their definition of risk?
How stable is their current job? Do their income sources fluctuate?
Do they have children? Do their children live at home?

The more you know about your client, the more comfortable you — and they — will be having open conversations about risk tolerance.

2. Employ Risk Assessment Tools

Measuring risk tolerance is a delicate dance, as much of an art as it is a science. And in all manners of science, it’s good to rely on proven methods and objective third-party tools.

Farm Bureau provides its Wealth Management Advisors with access to Riskalyze, a software built on the premise that a client’s risk tolerance can be quantified into a single number.

Riskalyze works by offering advisors a risk questionnaire to share with clients; once completed and the data inputted, the software assigns a “risk number” based on a client’s answers. Advisors use that number to create nuanced portfolios that reflect a client’s exact amount of risk tolerance, risk capacity and risk requirement.

3. Manage Expectations

It’s important at the outset to set the right expectations with your client. In the most basic terms, the higher the risk tolerance, the greater the potential for loss; the lower the risk tolerance, the lower the potential for returns. On some level, clients understand this, but reiterating it helps alleviate confusion and clarifies conflicting definitions of risk tolerance.

It’s also useful for clients to visualize how risk can affect their portfolio. Riskalyze allows advisors to show mock portfolios so that clients can literally see possible outcomes. This enables you to manage a client’s understanding of risk and manage their expectations for how their own risk tolerance will affect their portfolio.

4. Be Adaptable

Always take into account that a client’s risk tolerance should change over time. Life milestones, aging, employment changes and national and global events all affect a client’s risk tolerance. Be flexible and revisit the risk conversation as often as necessary.

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