Nearly 75% of investors would rather have portfolio protection than portfolio performance.1 This preference nearly perfectly squares with how financial advisors report they prioritize clients’ investment and retirement planning strategies, as 74% put wealth preservation/risk management at the top of the list.2
On its surface, this alignment suggests harmony; clients want protection and advisors are willing to provide strategies accordingly. For investors in higher wealth tiers, this approach is likely appropriate. However, those investors with $250,000 to $500,000 in investable assets could find themselves ultimately lacking sufficient savings to fund retirement in spite of being cautious about preserving their accumulated wealth and minimizing risk.1
Risk Aversion and Human Nature
The perennial challenge for advisors is moving conservative clients towards balancing downside protection with growth potential. Evaluating clients’ risk tolerance is both a requirement and a top priority for financial advisors,3 but it is an imperfect science.
Why? Clients must largely self-assess risk tolerance and could simply misjudge it,4 potentially leading to panic decisions that some industry experts calculate could result in a loss of assets totaling anywhere from 8% to 15% over a 10-year period.5
To accommodate investors who are less inclined to assume more risk, advisors may best serve clients by educating them on why more risk is necessary and suggesting possible paths toward growth potential in their portfolios.6 What can’t be ignored, however, is human nature. Clients will ultimately make their own decisions, but that shouldn’t dissuade advisors from broaching the subject of how assuming portfolio risk that could be in their own best interests.
To that end, advisors must seek to better understand the risk-averse client and adopt counseling strategies that resonate with their mindset. The approach may not get risk-averse clients to re-think their portfolios immediately, but being aware of and addressing these three prevalent behaviors builds client-advisor trust that could eventually lead to less guarded, more receptive conversations about risk-return balance:
1. Clients who protect their portfolios are generally anxious about wealth preservation. It’s not uncommon for risk-averse clients to be highly sensitive to market volatility and fluctuations in portfolio levels and account balances. Advisors who are proactive in reassuring clients about the reasons behind perceived “threats” and suggesting available actionable next steps, if any, will head off undue client panic.7
2. Clients who protect their portfolios may be doing so to ensure a legacy. Commitments to spouses, children, grandchildren, etc., could be the driving force behind clients avoiding financial risk. Advisors may find opportunities to use these types of client-defined obligations to provide a new perspective on how their investment decisions now — including risk tolerance and management — could impact future wealth transfer.7
3. Clients who protect their portfolios may feel financially powerless. Risk-averse clients may consider themselves victims of the market rather than decision makers in their wealth management. To help correct this misperception, advisors should look for ways to empower clients with active control of the process — perhaps by encouraging them to craft a vision and mission for their wealth.7
Not all clients see risk as a potential route to wealth accumulation, and they may well be correct in their given situation. However, advisors who are willing to challenge these beliefs and suggest appropriate risk opportunities often serve their clients’ best interests. It also encourages prospective clients to look further into the value of a relationship with a financial advisor, as detailed in our investor guide, When and Why Should I Hire a Financial Advisor? Click the button below to access your copy now.
1ThinkAdvisor, 75% of Investors Prefer Protection Over Profits: Ceruli, August 9, 2018
2Proactive Advisor Magazine, How financial advisors talk about risk management, October 24, 2018
3Bradenton Herald, Investor’s column: Examining the risk tolerance of you and your financial advisor, July 23, 2018
4Financial Planning, Kitces on risk tolerance: The misperception that keeps hurting clients, February 2, 2018
5Morningstar, Coaching Risk-Averse Investors in Times of Market Volatility, April 3, 2018
6Kitces.com, When Clients “Need” More Risk Than They Can Tolerate: Adjusting Portfolios, Or Goals?, October 24, 2018
7Wealth Management, Counseling the Risk-Averse Client, August 17, 2017