When a Client's Risk Number Surprises You

By Michael McDaniel, Chief Investment Officer

I’ve used Riskalyze in my practice long enough to have witnessed some surprising results from client risk questionnaires. I’ve had 80 year olds with extremely high risk numbers and 30-somethings with almost no tolerance for risk.

One of the things I’ve had to realize is that I’m often seeing a client’s real risk tolerance for the first time. Our industry has trained us to assume that age is the primary driver of how we invest money, so we tend to stereotype clients and group them into their respective decades.

The reality is, risk tolerance is much more about finding an individual client’s threshold for pain, so we can stay within it, and avoid the “buy high, sell low” cycle that has robbed average investors of about three quarters of the returns they should have captured over the last two decades.

In other words, people don’t always fit into the nice little boxes stereotypes would have us believe.

When a risk questionnaire’s results surprise me, I use it as a reason to start a discussion with the client. One of the first things to do is confirm that they used a meaningful investment amount, and that their devastation amount was truly devastating and not just an “acceptable loss.” (To get accurate data out of a Riskalyze risk questionnaire, we have to have an accurate starting point.)

Assuming the client did base the questionnaire on real dollar amounts, the discussion is paramount. For those with low risk tolerance and hefty financial goals, a reality check may be in order. “Mrs. Jones, to have a chance at hitting your retirement goals, we’re going to need to get you comfortable with a bit more risk.” Or “Mrs. Jones, we can stay within this risk tolerance, but that means you need to save more every month, or expect less income in retirement.” 

For those with a higher risk tolerance than their finances require, a different discussion is warranted. “Mrs. Johnston, I know you can stomach this much risk, but you have put yourself in a financial position where you don’t need to.” Or “Mrs. Johnston, I know you can handle a high level of risk, but we’re already on track with a conservative approach.”

I use the questionnaire to get the discussion moving, and focus the rest of the conversation on the portfolio’s projected performance range. “Given your objectives and your risk tolerance, here is the portfolio I recommend. Six months from today, this portfolio has a 95% chance of ending up between…”

Bottom line: understand that you may be seeing a client’s true risk tolerance for the first time. And use surprising answers as a catalyst to drive those important conversations with clients, and a reminder of how important your role is as their risk manager.