By Mike McDaniel, Co-Founder and Chief Investment Officer
Our data suggests that advisors tend to anchor their client portfolios to their own risk/return preference. Without an objective, quantified process, many advisors buoy their client’s risk/reward composition to their own preferences, often unaware that they’ve done so. In this subjective approach, an advisor uses his risk/return preferences as a baseline. Based on available information, the advisor will place the client’s preferences just above or below their own, not straying too far from where they are most comfortable. If an advisor is risk-seeking or risk-averse, it will be reflected in client portfolios, which can lead to disruption. When a client feels uncomfortable with the dips their portfolio is taking and the advisor doesn’t understand their apprehension, anchoring may be to blame.
Such a tendency can have a profound impact on advisor-client relationships. When subjective terms and a buoying approach are used, true individual risk/return preferences are ignored. This will invariably mean that some clients are invested outside of their risk preferences, setting the relationship up for failure.
Two scenarios come to mind.
First, and especially when a subjective onboarding process is used, a savvy investor should focus on finding an advisor who has a similar risk tolerance to their own. Asking a prospective advisor how much of their portfolio is invested in stocks could help identify—to a limited degree—the advisor’s risk/return preferences. If the advisor is using Riskalyze, the investor could ask the advisor what their Risk Number is (mine’s a 34).
Second, an objective, quantifiable process that calculates each investor’s risk tolerance can help an advisor prevent anchoring from happening in the first place. Our patented Risk Number® technology objectively calculates an investor’s true risk tolerance utilizing a scientific framework that won the Nobel Prize for Economics. This prevents unconscious advisor bias and makes sure that portfolio risk is custom-tailored to the client.
Knowing the Risk Number of each client and the Risk Number of various portfolios can help ensure that an advisor is providing objective advice, tailored to the client’s unique appetite for risk—not the advisor’s. The Risk Number approach can also reverse the negative effects of buoying risk/return preferences across an advisor’s entire client base. In fact, it’s common to have a new Riskalyze advisor realize their client portfolios are “clustered” around their own Risk Number all along!
Knowledge of the anchoring tendency isn’t enough. Advisors and clients need to have a quantifiable and engaging approach to not only overcome the effects of anchoring but prevent it in the first place.
If you’d like to know more about how the Risk Number, check out our Riskalyze 101 posts and see what makes us tick.
What? Not using Riskalyze yet? Let’s give you a personalized demo.