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5 Ways to Better Manage Clients' Risk Tolerance, Expectations

5 Ways to Help Manage Clients’ Risk, Expectations 5 Ways to Help Manage Clients’ Risk, Expectations

Advisors with a robust advisory process generally generate a high level of client loyalty and build lasting value in their firms.


Here’s an interactive slide show detailing 5 things you can do to effectively manage client expectations and risk tolerance, enhance relationships and protect your firm's value.


Source: Geoff Davey, co-founder of risk-profiling and risk-tolerance firm FinaMetrica.

1. Prove You Really Know Your Client 1. Prove You Really Know Your Client

It’s essential to have a good understanding of client assets and liabilities, as well as present and future preferred and minimum cash flows. You should be able to illustrate this to clients in words, numbers and pictures.


Critically important here is determining the client’s risk capacity. You must establish how much your client could afford to lose without messing up present and future life plans. This usually means stress testing the client’s current and future balance sheet, particularly their investments and then reviewing future spending to assess whether they will need to change their expectations or find more investable assets.


You also need to have a good understanding of your clients’ financial risk tolerance so that you can factor it into their financial plan. Risk tolerance is best defined as “the level of risk an individual would accept in their financial affairs if goal achievement was not an issue.” For couples acting jointly, the risk tolerance of each needs to be taken into account in the planning process.

2. Demonstrate the Breadth of Your Strategic Expertise 2. Demonstrate the Breadth of Your Strategic Expertise

This might simply start by using some or all of the cash which has been set aside for investment to discharge non tax deductible debt. Other strategies may include the need to work longer, work harder, spend differently, change jobs or perhaps set up a business. The overall goal is to illustrate the client’s lifetime cash flow position, allocating spending between now and the future on a logical basis.


The advisor must work with the client so that they can jointly determine the level of financial risk that the client is prepared to accept in pursuit of his/her goals. Generally risk is translated through to the amount and type of risky assets, such as shares and property held, compared to safe assets such as cash in the bank.


Some clients may choose to hold more non-risky assets even though they might have less chance of achieving their future goals. Critical here is both client education - illustrating what can be lost - and an understanding by the client of the impact on their plans if that loss occurs.

3. Know the Products That Match Your Clients’ Strategies 3. Know the Products That Match Your Clients’ Strategies

Once you have decided on the strategy and relevant products you need to understand those products so you can argue that they appropriately meet your client’s needs. External research can assist you in making product recommendations but ultimately the adviser is responsible for the final recommendation.


The key issue is to understand how the investments will behave when the markets fluctuate. Many investments work well in good times but have a history of failing in bad times. A good understanding of economic history is needed when stress-testing products.


The traditional asset allocation process assumes the classic assets of cash, fixed interest, stocks and real estate. While there may be volatility, it is unusual for a portfolio to go to zero value. The minute you add financial engineering, be it gearing, derivatives or securitization, you change the character of the asset. In short the value can – sometimes very quickly – go to zero or become negative in the case of gearing.

4. Explain All the Risks—Completely 4. Explain All the Risks—Completely

As well as illustrating the more probable outcomes you need to explore the worst possible cases. You must be able to illustrate extreme events and explore clients’ risk capacities. You must be able to show the consistency of the financial plan with the client’s risk tolerance. You must have effective processes for setting performance expectations and their ongoing management.

5. Confirm Client Consent For All Investment Strategies 5. Confirm Client Consent For All Investment Strategies

Having illustrated the client’s balance sheet over time, and having taken into account extreme events and the client’s financial capacity to cope, you need confirmation that the client has given their informed consent to the plan and accepted the risks in both the plan and the investments recommended. This in turn leads to the client's explicit instructions to you to proceed.


Also see:

AdvisorTV: Dealing With Risk: Part II

AdvisorTV: Dealing With Risk: Part I

The Art of Conversation: 8 Tips for Successful Advisors

9 Ways to Keep Clients From Overspending in Retirement

7 Top-Rated Investing Books

Photo Credit: Tim Pierce

Here’s an interactive slide show detailing 5 things you can do to effectively manage client expectations and risk tolerance, enhance relationships and protect your firm's value.

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