Can you profile risk?

Part of the process advisors go through with investment clients is to measure their ability to accept volatility/risk in their portfolio. This is done through the use of risk profile questionnaires. While I’ll admit you need to understand a client’s preferences when it comes to risk, I think the use of questionnaires is flawed, as it is a single point in time measurement of something that is ever shifting and changing.

How a client views risk at any given point is affected by not only their personal preference, but also recent history (market and otherwise) and social pressures. When the market was flying high, many clients likely saw themselves as being able to accept more risk – the upside was tangible. When the market dropped, even some of the most aggressive clients decided it was time to get off the ride, and retreated into cash.

Studies by Andrew Lo show that the success or failure of day traders (think investors who rip through many market cycles every hour) are related to not their current view on risk, but how far they swing up and down the continuum in response to the market. Those that remain relatively unchanged, and have ‘iron guts’ do better than those whose emotional reaction to the movements of the market are strong and act on their discomfort or elation.

We need to see a client’s ‘risk profile’ not only as an unchanging point, but as a range. And your true value as an advisor and steward of your client’s wealth is to understand this about each client, and help those with wide-ranging reactions not act when not acting is the right thing to do.

Nothing for nothing

A popular way to add value to a purchase is to give something for free. Beer companies add t-shirts in cases. Grocery stores give a gift card if you spend enough.

It is a very successful way to influence purchase decisions, but there is a risk. Whatever you give away becomes devalued – you can’t sell it ever again at a premium. As a financial advisor, you need to be very careful what you give away for free without a thought.

Advisors who provide financial planning as a free service, and tell the client that the insurance companies or fund companies or whatever pay them is an example. Doing this makes it almost impossible for them to transition to a ‘fee for service’ model, where they now expect clients to see the value of paying for that which was once given away for free.

That’s not to say that you can’t offer it without charge. I know there are many advisors who are new to the business, or ones who are just getting comfortable with the idea of charging for their services. Just make sure everyone knows there is value to your services. Figure out a fair value, and tell people, “I charge $x for a comprehensive financial plan, which I am willing to offer to you without charge if you are willing to commit to placing whatever products will be required by the plan with me.” This will this establish value for your services. It will gain commitment from the client, so you do not end up ultimately doing all of that financial planning work for free.