When it comes to investment risk, many financial advisors feel that clients “just don’t get it.”
In this webinar replay of “The Right Way to Talk to Your Clients about Risk” with Aaron Klein of Riskalyze, we address the responses (posted by webinar participants) to this question below – and more!
What is the #1 frustration you have when talking to your clients about risk?
Frustration—-the fact that clients have recency bias—-they favor the short term trend and forget to remember that their plan is built for the long term and that should be the focus. A perfect example is the market correction in December that damaged year-end portfolio statements. When clients called in mid-January to discuss, they had failed to notice that 2019 performance has led to portfolio recoveries——letting their plan work as it is intended will allow them to reach their goals.
Clients positioned in lower risk equities (large cap value) with lower returns, but wanting returns of riskier equities (small cap growth) and blaming me for investment selection–
The biggest frustration I have when talking about risk:
- They get the concept of risk when it comes to the fluctuations on stock
- They don’t fully grasp the concept of risk when talk about interest rate risk and purchasing power risk
- They want low risk but high returns
Clients (and journalists) do not think in terms of risk (future outcomes will distribute across a range of possibilities). They think in terms of straight lines (whatever happened before will happen again the same way).
How can we communicate the fundamental truth of risk of investments in simple, understandable ways?
The RTQ’s are great but I don’t think they do enough. I’m definitely interested in learning more about how risk can be communicated.
They think they can tolerate more risk than they really can. This is usually revealed when markets drop.
They don’t understand between individual stock positions and asset class portfolio investing.
Generally with younger clients is explaining (at least for our firm) that we are wealth managers and not market timer or day traders, so we do not go out to “beat the market”. If anything, those attempts are more risky than the strategies we implement.
As you know, how someone feels about risk is very subjective and, typically, can vary from day to day. No matter how the risk tolerance questionnaire (“RTQ”) is worded, many clients will answer the exact same RTQ differently each time they complete it. Additionally, most RTQs do a fairly horrible job of incorporating the clients’ CAPACITY to take risk. Consequently, when clients are on the edge of a risk range (for example, if your firm has 5 ranges – conservative, conservative growth, moderate/balanced, growth, aggressive growth), this can create portfolio construction issues and demands additional forethought to avoid substantial differences in portfolio standard deviation (e.g., low range of moderate/balanced vs high range of a growth portfolio).
Explaining that long term growth comes with short term volatility.
The idea of risk is not “real” to some clients, and they only care about returns. I show them actual dollar amounts, of what a stress test against 2007 to 2009 would look like with their own portfolio, and there’s a sense of denial like, “Well that’s not going to happen again and you’d change my investments if it did, right?” I explain that it’s impossible to guess ups and downs, and I won’t jump in and out of the market… and they still insist on a risk level higher than what they should. Then, when we get a situation like December 24, 2018, they freak out.
I work a lot with educating clients about risk; and I’m pretty good at it. But there are still some of those clients, no matter how many times you talk to them, ad nauseam, about risk, they still just don’t get it.
The number one frustration with clients regarding risk is that they forget what they said they could tolerate on the downside. More importantly, as we saw this fall, it is the daily, grind it out, downward, volatile swings which the risk tolerance questionnaires just do not prepare people for. They spend too much time looking at their phones and t.v.
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