Some guidelines for financial planners in measuring and advising clients about their levels of risk tolerance

Abstract

The aim of this article is to provide advisers and planners in the financial services industry with an outline of the key issues to consider as they develop an understanding of the risk tolerance of their clients. Risk tolerance is the assumed level of risk that a client is willing to accept. Through gaining an accurate assessment of a client's risk profile, an adviser can develop a tailored financial plan that better reflects the client's perception of the acceptable trade-off between risk and the compensation required for bearing risk. By making the client's risk tolerance explicit and understandable, the planner is able to help the client identify any mismatch between psychological and financial needs, then work with the client to make any trade-offs that might be required. However, in contrast to the views of some financial writers, it is argued that risk tolerance is a complex attitude that requires the use of a sophisticated and complete assessment process. Most importantly, the use of a scientifically developed measure of risk tolerance within a structured process set up by the financial planner provides the best approach to determine the risk tolerance of clients. A risk tolerance test score or profile provides the adviser with a good basis upon which to explore further in the interview the type of investments that a client is most likely to find to be acceptable. In addition, using a test of risk tolerance that has established test norms allows the adviser and client to understand how a client's level of risk tolerance compares to other people who have completed the same profile. Finally, the article raises other issues that need to be considered in assessing the risk tolerance of a client, including the format and wording of a measure of risk tolerance, whe...

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