Realistic Risk Tolerance Goals - Learn & Educate How to Set Up


Helping Financial Advisors Know Their Clients – Risk Profiling, Client Psychology, Behavioral Finance, Compliance

How to educate clients to set realistic goals based on their risk tolerance and capacity ?

The risk questionnaire is not an instrument that collects information about a client in order to automatically assign him a type of investment. It is a way to get to know the client and his goals, priorities and behavior in order to help him make the best decision that is suitable to him.

Clients have different goals and it is important for an adviser to know if they are realistic in order to avoid eventual disappointments from the part of the client. An unhappy client may affect company’s reputation & credibility so that is why an adviser has to ensure that the customer has all the information and is aware of the investment risks. If a client has required knowledgebase this can help him make the best decision and also be more understanding and patient when the evolution of the market is unfavorable.

The client must have a certain degree of financial literacy and if this is not the case the adviser must talk to him about portfolio composition, market volatility and the tradeoff between risk and return. These explanations do not have to be very detailed but they have to present the general picture of the market and of the economic cycles so that the client understands the risks but also the advantages of investing in the assets of a portfolio.

It is known that the goals of the customers can variate widely and can be about wealth accumulation, retirement funding or saving for a large purchase. It is important that these goals are suited to the financial situation of the clients and their risk tolerance and capacity. A high risk tolerance can also be interpreted as a favorable attitude toward risk or risk appetite. A high risk capacity means that the client has enough funds in order to not be seriously affected by a market decline at least to an extent. If the client has the right attitude and the right financial stability, risk becomes less of a liability and more of a chance to obtain profits.

The problem with the goal of getting rich is that it is an oversimplification, so it can be reformulated as improving one’s financial situation to an extent. The extent in question is determined by the assets, cycles and properties of the market. The client must also be aware that the improvement in his financial situation is visible only in the long term and until then periods of portfolio appreciation and depreciation can appear.

There are no right attitudes toward risk as it depends on the individual. Somebody who has risk appetite is not necessarily more informed or entitled to his opinion than somebody having risk aversion. After a decline in the market it is not obviously correct to sell assets or give up on investments as the decline period can persist or a market rally can appear.

It is important that the client can argument his attitude about risk so the adviser can understand and offer him the type of investment that is most suitable. A client with an uncertain source of income or with a low risk capacity shouldn’t choose a high volatility portfolio even if he has a high risk tolerance. In cases such as these the adviser has to talk to the client in order to ensure that the investor is not affected too much about the losses in specific periods in order to be in a position to gain in the long term and is aware that overall he can obtain real profits.

The main point is that the goals of the customer have to be balanced with the risk tolerance and capacity. The risk questionnaire collects information quickly and accurately that shows if this is the case and if not the adviser has to talk more with the client so that an accord is reached about the best course of action after the client has received all the relevant information. A higher goal requires the client to contend with more uncertainty by investing in a riskier portfolio and the risk tolerance and risk capacity have to be aligned to this approach.