Investing, Self-awareness and Tolerance to Risk
Before you can embark on any financial plan on behalf of a client it’s essential that you understand their tolerance to risk. You must also know what their goals are, ensure they are achievable and keep them committed to the plan for the long term.
Develop self-awareness to identify your client’s tolerance to risk
Any good investment approach starts with introspection. Every investor has their particular personality traits, their own goals and biases. Just as every top baseball player has their own particular way of playing the game, every investor has a different approach to investing.
As an advisor you need to become self-aware and sensitive to your clients’ feelings, you need to use your intuition. You need to be in tune with how your clients feel once they have acquired a security too to ensure they don’t panic or want out during an inevitable downturn. In order to help them get the much-needed long-term returns you will need to become more self-aware and have empathy with clients.
So how can you better understand your clients’ attitude to risk?
Find out as much as you possibly can when it comes to your client’s situation in life.
Life events can make people more cautious. People with friends and family who have suffered a stroke tend to value critical illness cover more than those that don’t. Similarly, people who have suffered from bad investment advice are more likely to err on the cautious side in future.
How can you reduce your clients’ perception of risk?
Tell your clients that reducing risk by not investing money is ‘to go broke safely’. All risks, including safer investments, have consequence – you need to focus on the perspective of the level of risk.
To reduce a client’s perception of risk around investing try using the following analogy: Going to the dentist may involve pain, but the alternative is more painful, and the same applies when taking on the risk of an investment. By avoiding risk altogether i.e. deciding not to invest, we’re creating a worse situation – that of missing our essential long-term objectives, for example the ability to retire comfortably in 20 years.
The head does not determine investment success, the stomach does.
Once you determine your client’s tolerance level you will know whether he or she is aggressive or conservative. In reality it has to be said that the vast majority of clients are relatively risk averse – they are not looking to amass a fortune – they simply want to see their kids through college, or save for retirement.
You can then use this to build an investment that matches their comfort level – one that will achieve their objectives. The portfolio should match that client’s attitude to risk.
To minimize their perception of risk once they have invested, assure your client that how he or she sleeps at night is important to you. Emphasize that you are dependable, and are in this for the long term. When markets dip the client’s perception changes. As an advisor you see a ‘loss of momentum’ and a ‘temporary buying opportunity’ whereas clients see a market that is heading down without passing ‘go’.
You need to reassure them when markets take a hit. Stress that there’s no need for them to react to a collective panic attack. As their advisor you are constantly looking out for them. In effect be ready to give them a metaphorical ‘hug’.
When it comes to determining your clients’ attitude to risk no drawn out questionnaire can do this effectively. You need to get personal and use your own self-awareness and intuition to detect this. Without taking the time to know your clients and comfort levels your advice is likely to be unsuitable for them – and this only leads to trouble.
Get this mp3 where Don tells you exactly what to tell clients.