By Karin Price Mueller
Before you invest a penny for your clients, it’s vital to understand their risk tolerance. It will guide you in making smart recommendations for them and will help them recognize what you’re trying to accomplish for them.
Step 1: Test the waters.
Risk-tolerance questionnaires are a good way to start, but they’re just the first step. “They sometimes try to fill out the questionnaire hoping it will make them the most money,’’ says Vince Pallitto, CFP, CPA, who is president of Summit Asset Management in Florham Park, N.J., and manages nearly $200 million in assets. He says posing hypothetical questions, such as asking if a client would invest in a friend’s business, or if they gamble, can give you a better feel for a client’s true comfort with risk.
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“I do it in a very nice manner, but I do bring to their attention the inconsistencies in their thoughts.” —Thomas Belisari, CFP |
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He also says that using illustrations with real numbers is another strategy. “Let’s say they have $100,000. I write it down, and say, ‘What would you think if it goes down to $80,000?’ and I write that number down and show them,’’ he says. “If they’re truly aggressive, they should be able to stomach it. You can see it on their face.’’
Thomas Belisari, CFP, an associate with Key Financial Inc. in West Chester, Penn., also learns from a client’s current investments. “Seeing how their 401(k) is set it up is often a mirror of their soul, and I ask if they made the investment choices or if someone else did it,’’ he says. If they did it themselves, he says he can learn a lot about them. Belisari manages approximately $48 million in assets for clients who run the gamut from young to old, wealthy to not-so-wealthy.
Step 2: Know your client.
Life experiences impact how people feel about money. Growing up poor will yield one attitude, while being born with a silver spoon yields another. It’s also important to understand a person’s investment experiences. Belisari uses informal meetings to learn about clients so he can find something they relate to. “Let them tell you in their words; that’s the key,” he says. “I look at their personal circumstances and listen as they talk.’’
And never make assumptions. Belisari tells the story of one client who visits Las Vegas two or three times a year. You might think she’s aggressive, but no. She plays nickel Keno, a game that you can play for a very long time without getting financially slaughtered. If her game was roulette, Belisari would use a very different approach.
Step 3: Prepare for challenges.
Clients may believe they fall into one risk tolerance category, but they’re often wrong. If a client says she’s aggressive, but she’s not comfortable with riskier strategies, Belisari says he simply “calls them out.” “I do it in a very nice manner, but I do bring to their attention the inconsistencies in their thoughts,’’ he says.
Or, take the overly conservative client who needs a higher rate of return to reach his goals. Dennis Carpenter, CFP, owner of International Wealth Management in Grapevine, Texas, uses a retirement model to show if a client’s plan will mean a surplus or a deficit in retirement. “A picture is worth a thousand words and once presented with the facts, the client will need to decide which they are more comfortable with—potential volatility within their portfolio or falling short of their goals,’’ says Carpenter, who manages money for a broad range of clients, from blue-collar workers to athletes and performers.
Belisari uses another tactic. He asks clients about how their expenses, such as the cost of gasoline and food, have risen over the years. Because clients see inflation in those costs, they will grasp the need for some level of growth.
Pallitto says some clients with every dime in fixed income won’t budget even after seeing negative-outcome charts. He offers annuities with guaranteed-income riders for these clients, so they can earn a minimum return, plus the upside, but not the downside, of the market.
Married couples who are on opposite ends of the risk spectrum are also common. If it’s an IRA or a 401(k) account, most planners invest in a manner consistent with the wishes of the owner of the account. Joint accounts are trickier. With those, Belisari generally goes for a compromise. “If one is ‘pedal to the metal’ and the other wants to hide it under the mattress, it’s going to be a balanced portfolio kind of approach,’’ he says.
Karen Price Mueller is a New-Jersey based financial-services writer.
October 2007
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