Conversation starter – 3 ways to get clients to open up about risk

Standard questionnaires aren’t always effective for understanding clients’ risk profiles. You also need to be aware of the difference between financial and emotional capacity for risk. On paper, some clients look as if they can handle more risk than they’re actually able to stomach emotionally. Others seem ready to swing for the fences, but their finances and timelines warrant a more cautious approach.

Here are three ways to help uncover your clients’ capacity for risk:

Approach #1

Take clients through the ‘boat is sinking’ exercise.

“How low will you allow the boat to sink before you jump? With $1 million would you jump after losing $30,000 (or 3%) or $100,000 (10%) or $500,000 (50%) or somewhere in between?”

A 30-year-old, high-earning professional who’s ready to jump at 3% may need to up her risk; otherwise, she may miss long-term retirement targets. Find out her retirement lifestyle goals and assess them against income expectations at her current risk threshold. She may be willing to take a more suitable level of risk if she learns her current view will leave future goals underfunded.

Approach #2

Ask clients to discuss the recent recession and how it affects their view of risk.

Did the meltdown rattle them long-term or did the equity market’s subsequent recovery restore their confidence?

While most portfolios have recovered from the downturn, a recent poll shows boomers in particular are worrying about another major decline. What does this mean to them in non-financial terms? What are they worried about missing out on, or not being able to fund?

Approach #3

Ask them to describe their understanding of the risk profile of the various asset classes to pinpoint misconceptions that may be artificially increasing or decreasing their risk capacity.

“Rank the risks of stocks and bonds on a scale of 1 to 10 and explain your rationale.”

If a client pegs bonds at 1 and stocks at 10, you know there’s some work to be done on the education front.

He doesn’t understand, for example, that even the safest bonds carry more risk than many think. Similarly, he may not appreciate some stocks are safer than certain bonds.

Correcting such misconceptions will help recalibrate your clients’ perceptions of risk to match their circumstances.