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I recently asked several of my colleagues their thoughts on coaching advisors around the "risk tolerance" conversation. Here is what they had to say:
Jim Privette
"I have made the point that there is the knowable and the unknowable. The knowable is the client insight, the unknowable is what the markets will do next. I ask advisors what their client conversations are about these days and the answers are "should I get out?" or "what stocks to sell or buy" (timing and stock selection). The 7 step interview focuses back on the knowable and the most important decision (asset allocation). I think we need to couple the risk tolerance question with today's unprecedented volatility. Clients current beliefs about risk are being challenged. I encourage advisors to "understand the clients assumptions (based on their experience)and guide the client to rethink risk in light of current market conditions. Risk tolerance will ultimately be about long term outcomes but volatility assumption about asset classes and their historic performance and characteristics are on trial and each day gives us new evidence."
Phil Buchanan
"On the tolerance for risk issue, I've been breaking it into two pieces:
1. The typical up/side down side capture question ---- but I've added time periods of one day, one month, one year and five years, but benchmarking off the answer to the one year question. My reasoning is that so many people are focused on day to day fluctuations that they can't make rational judgments. However, by putting the full range of time elements on the table, it forces the client to "confront the noise".
2. The new element/wrinkle I've added is "Absolute Stop Loss" threshold. What is the $ value you do not ever want to fall below - followed by how would the proceeds then be managed, followed by what would be the plan for re-entry. Of course, this is a great place to highlight "Issue & Consequence" questions."
Larry Divers
"I am very passionate about this topic and I have always set up the +/- 20% in the investment interview around the best case worse case scenario. The 20 %( rounded) is the long term standard deviation of the S&P 500. This number however is based on one (1) standard deviation not two (2) or three (3) standard deviations. Thus, the current market conditions are not outside of the realm of probability and they have happened the past. That is why we need to point out to our clients the best and worse case scenario on one, two and three standard deviations. From a compliance standpoint this also works well."
Daniel Smith
"I preface that this is a gauge as to risk tolerance in normal market conditions, the time frame is not important as long as it isn't short, and the percentage isn't important as long as it is the same up and down, and that by asking it both ways you assumptively close to the fact that the answer needs to be relative up and down. If the client does not answer that way, stop and have a conversation about it. And in today's market environment there may be other risk tolerance comments are your clients are considering. I think it is important that the 7 Step is a conversation model, not 7 questions that will give you the magic answer, rather it is a framework for appropriate and complete discovery."
I have been coaching advisors to include questions like "What has been your experience investing." "What has worked well you and what hasn't?" "How did you feel about that?" "What role did emotions play in the decision making process?" Ultimately you need to really understand where your client is coming from, but at the same time they need to understand that if they let emotions entirely drive their decision making they may be at even greater perril.