By Mark Friedenthal, Founder & CEO, Tolerisk
Financial advisors have assessed risk tolerance for decades using a brief personality-based quiz with multiple-choice responses. These questionnaires produce nebulous results, often characterizing most individuals as “moderate” and providing little information that might help clients make informed decisions. They also offer minimal insight for advisors. Consequently, many advisors have long viewed risk tolerance questionnaires as mere compliance requirements rather than foundational elements for sound financial planning – and certainly not as a tool they could use to have better conversations with clients about risk.
However, as the financial industry continues to take a more holistic approach to financial planning, the concept and practice of assessing risk tolerance has also evolved. Prominent industry juggernauts are bringing risk tolerance squarely into the financial planning conversation from its prior position as a compliance afterthought.
Still, most existing risk tolerance solutions assess risk one-dimensionally, focusing solely on a client’s willingness to accept risk, not their ability to take it on.
We believe the future of risk tolerance lies in a far more comprehensive approach that gauges a client’s ability to take risks alongside their willingness to do so. Risk tolerance can and should be a powerful catalyst for building stronger client relationships through better financial longevity assessments, insights into portfolio performance as it relates to risk, and full transparency around potential portfolio outcomes.
How can financial advisors use risk tolerance to improve client relationships? It starts with more advanced risk tolerance solutions, including:
Robust Risk Tolerance Assessments: Assessments should incorporate dynamic risk scores that evolve with the client’s financial situation, consider historical scenarios for assets and inflation, and project actual returns for better financial longevity assessments. Ideally, the evaluation should also consider the uncertain lifespan of both partners using mortality probabilities that include age, gender, and various health and lifestyle factors.
Portfolio Comparison Tools: Cutting-edge portfolio comparison technology allows advisors to score various portfolios on the same scale, enabling side-by-side comparisons. This provides clear insights into performance, risk, and alignment with clients’ financial goals. Additionally, it enhances the proposal generation process by offering comprehensive and easily understandable comparisons.
Probability of Returns Visualizations: Charts that offer clear visual representations of potential returns within a selected date range empower advisors to confidently guide clients toward informed investment choices with a deeper understanding of potential outcomes, helping to foster trust and transparency.
Why is all of this so important to an advisor’s practice?
A sophisticated, multi-dimensional, and dynamic approach to risk tolerance transforms it from a compliance checkbox into a powerful tool for growth, retention, and building client confidence with increased referrals.
Consider the common client concern: “Am I going to run out of money?”
Even if the answer is not, there’s a significant difference between an advisor simply saying no and an advisor showing the client calculations demonstrating less than a 1% chance of running out of money. The latter builds trust and illustrates the advisor’s diligence, enhancing the potential for client retention and referrals while helping to minimize doubts about their financial path.
From a compliance perspective, a highly scientific approach to risk tolerance creates an objective, repeatable, and documentable process that ensures consistency across an advisor’s practice.
Risk tolerance can be so much more than just a checkbox. Leveraging cutting-edge technology to drive the risk tolerance conversation will guarantee a significant competitive advantage for growing firms.
Mark Friedenthal is the founder and CEO of Tolerisk®, an analytical, multidimensional risk-tolerance assessment tool designed to improve and enhance advisor-client relationships through in-depth risk evaluations. To learn more about how Tolerisk’s next-generation mathematical infrastructure can elevate your financial services business. Book a demo today.
