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In Risk Tolerance, Education Trumps Assessment

December 28, 2016

Financial advice clients struggle with understanding risk tolerance, and it’s the advisor’s job to educate them — and often pick the right approach themselves, advisors tell CNBC.

Kevin Reardon, certified financial planner and president of Shakespeare Wealth Management, tells the news service that even his long-term clients find it difficult to answer the five points on a questionnaire the firm requires them to fill out every three years. And that’s despite the firm’s policy of requiring every client to go through a workshop defining risk and explaining how the firm manages it, CNBC writes. Reardon tells the website that it helps guiding clients through “what-if” scenarios that ask how the client would react to a market drop. Nonetheless, he says, any significant decline will always surprise some clients.

That’s because a client’s risk tolerance rises with the markets and vice-versa, Robert Wander, a certified financial planner and owner of Wander Financial Services, tells CNBC. Wander says advisors may have to go against a client’s stated risk tolerance to find the correct approach, according to the news website.

And Dana Anspach, certified financial planner and CEO of Sensible Money, tells CNBC that risk tolerance assessments “are useless” and protect the firm rather than the client. That’s because the assessments only measure the client’s emotional capacity for a significant drop in portfolios, she says. But assessments aren’t efficient at measuring the rate of return a client needs to sustain to reach their retirement goals nor the probability of achieving those goals based on their investment choices, she tells CNBC.

Anspach says educating clients is therefore more important than assessing their risk tolerance. Her firm offers presentations looking at historical returns and volatility as well as how different strategies would affect a client’s portfolio in those time frames, the news website writes.

By Alex Padalka
  • To read the CNBC article cited in this story, click here.