Know Thy Client

What is your client’s true risk tolerance? One of the most useful ways to gain a better understanding of a client is to better understand how environmental factors and stressors will affect their response behavior.

Blaise Pascal, a 17th century mathematical genius, discovered “uncertainty is about people, their beliefs and their courage, while calculated risk is based on information, knowledge and credible scenarios. Together, with his colleague, Pierre de Fermat, he came to the conclusion that people are naturally risk averse.”¹ Unfortunately, many investors have a distorted perception of the risk they are taking on.

Over the last decade, the study of investor behavior has become a growing subject of interest among university researchers. In an effort to provide due diligence in client asset allocation, many major financial institutions have created written suitability questionnaires, to include such information as investment experience, time horizon, liquidity needs, risk tolerance, other holdings, financial situation, tax status, and investment objectives. But still clients complain and seek litigation for money lost during market volatility even when the written risk assessment concludes that they should be able to tolerate the prescribed level of volatility. Could we be living in an environment where short written assessments yielding Conservative, Moderate, or Aggressive are not good enough?

Even if the client has all of the information and knowledge before investing, “…it won’t help much unless the investor really and truly understands the amount of money they stand to lose, the probability that this

will occur, and the personal or psychological effects this loss may cause.”² Maybe instead of talking about losses in percentages, we should talk in real dollars. Most risk tolerance questions ask, “Mr. Client, if your investment declined 5% in six months, would you be able to tolerate that?” Now change your question to, “Mr. Client, if you invested $1,000,000 and the market declined resulting in a $50,000 loss, would you be able to tolerate that?” Now watch their risk tolerance change in a heartbeat. Maybe the client is telling you they really don’t want to lose any money at all.

Today, many fixed index annuities offer time horizons as short as 5 and 6 years, no negative annual returns, liberal liquidity options and principle guarantees. If you know that your client seeks safety and guarantees, why take the risk to unnecessarily expose your client to market volatility? By using simple logic and asking the right questions, you can help your client determine their true risk tolerance.

Today, it’s truly better to... KNOW THY CLIENT.

¹Brian Bloch, “Using Logic to Examine Risk”, Investopedia, July 23, 2011;

²Brian Bloch, “Using Logic to Examine Risk”, Investopedia, July 23, 2011