Coming to Term | February 2002 Making the Transition

Making the Transition: Risky Business

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Use a time-tested risk-tolerance questionnaire to educate and advise clients.

By Donald Ray Haas, CLU, ChFC, CFP, MSFS

Last month's column discussed the purpose and misuse of most clients' risk tolerance questionnaires. For more than 25 years, I have used the Financial Attitude Questionnaire created in the 1970s by Denis Raihall, Ph.D., CLU. This time-tested quiz has also been published in an American College textbook. It is a very accurate indicator of your client's current attitude and understanding of market risk. Therefore, it is also a valid indicator of how your client will react to future market fluctuation.

Before using it with clients, take the questionnaire yourself and learn how to interpret the scoring. The questionnaire on the next page can also be found and downloaded at www.advisortoday.com. First, some instructions:

Question 1: Circle 1, 2 or 3 for each of the 10 listed places you could save or invest your money. Your answer should be based on how you feel about putting your money into each investment vehicle and not whether you are actually doing so today. If you feel comfortable, circle 3; if uncomfortable, circle 1.

Question 2: This is a hypothetical three-year investment. Again, how do you feel about investing under these three circumstances? Respond "yes" or "no" to each.

Question 3: If you agree with the first statement (yes), then the second part asks you to state what percent of your total investments you would be willing to invest under this circumstance, i.e., 5 percent, 20 percent, 50 percent or 90 percent?

Question 4: Your job is to prioritize these seven items. It is critical to rate the most important with a five, then a four on the next most important, etc.

Your next task is to complete and score the questionnaire.

Once you've completed it, here is what the scores mean:

Risk-averse clients typically have a total score of 0 to 5 points.
Clients who feel they must minimize risk while investing score 6 to 10 points.
Clients who score 11 to 15 points can handle most investment portfolios as long as risky investments do not exceed 10 percent to 15 percent of the total.
Total risktakers who can invest 100 percent in anything score 16 to 20 points.
Clients who score 21 to 23 points are gamblers; tell them a one-way ticket to Vegas is their best bet.

(Experience indicates that an individual's actual risk tolerance could be +/- 3 points.)

So far, you have determined a client's score and category, but you still need to know what investment vehicles to recommend. While you can safely assume that a client who is a "2" will never become a "22," do not assume that same client will avoid investment risk forever. If one of your clients scores a low number, you can assume the client simply does not understand how investments or insurance work. Because they have not yet assimilated the concept of investing, explain how both investing and risk management play a key role in a sound financial plan. Stress how diversification reduces risk and explain how professional investment advisors can prepare for, and assist investors through the inevitable ups and downs of the stock market.

In my practice, when a client scores from 11 to 17 points, I am comfortable in immediately recommending almost any investment vehicle, but use a low percentage of more aggressive vehicles. Here is another key point when interpreting risk tolerance scoring: Your client's score could be three points lower or higher. This mere three-point variance can mean taking a different educational approach with your client.

A score of 10 or below indicates that teaching the fundamentals is necessary if that investor is to become comfortable with even very conservative investments. It does not mean, however, that your client is forever relegated to FDIC-insured bank accounts. It means that time is needed to educate -- the lower the number, the longer the educational process. Developing a trusting relationship between client and advisor is a necessity and this process cannot be rushed. Of course, the best way to do that is to always place the client's interests first. Only recommend what you would apply to yourself if you were in the same circumstances. This is also known as the Golden Rule.

When you truly deserve, and have properly developed, this trusting relationship, your ability to serve is the greatest. And remember your income will be in direct proportion to the quality of service rendered.

Try using this questionnaire with relatives and friends first. Avoid making any client recommendations until you learn more. Later, when you have a more complete understanding, you can be extremely helpful to, and appreciated by, those you serve.

Next month, we will further explore investment risk tolerance, especially how to deal with clients who need to improve their scores to achieve financial security and independence.

Donald Ray Haas, CLU, ChFC, CFP, MSFS, of Southfield, Mich., has been an insurance agent and financial consultant for 46 years. Contact him at 248-213-0101 or Donaldhaas@aol.com.

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