Between developments in CRM2 and seg-fund disclosures
and conversations around banning embedded commissions
, the message to advisors is clear: the clients’ best interests have to be taken seriously. That means respecting client’s risk tolerances while ensuring effective returns — and that’s easier said than done.
Based on a long history of research, advisors know that equity risk is necessary for maximized long-term portfolio returns. However, as noted in a recent report from Cerulli Associates, investors are not likely to embrace that risk. When asked about their risk tolerance, fewer than 10% of US investors self-identified as aggressive investors, and almost 25% said they were conservative.
This preference toward safety is reflected in investors’ reported financial concerns. “Planning for retirement” was cited by 17.9% of investors, while “protecting current levels of wealth” was cited by 17.6% — most of whom didn’t have enough wealth to support a sustainable stream of income for retirement.
Even if they were financially able to accept more risk, many investors preferred safety not because of an inherent investment philosophy, but because of cognitive or emotional biases — which may be overcome with guidance from advisors. But dispensing that guidance can be a tricky balancing act: disagreeing with the client about the appropriate level of risk in their portfolio can expose advisors to complaints that may reflect on their disciplinary record.
Clients may be more willing to embrace risk if they had a deeper understanding of what goes into the investment-planning process. But as Cerulli noted, consumers — particularly the ones who seek a third party to help with their finances — are generally not interested in delving too deep into financial issues.
The more realistic solution is to supply information and explanations in small doses. When getting an investor to sign off on applications and disclosures, an advisor can give them just enough background information to make them feel comfortable with any recommendations.
By making the discussions focused on the client’s ownings, return objectives, and the risks necessary to achieve them, advisors have a better chance of improving their engagement levels. At the same time, they can reduce the gap between clients’ actual capacity for risk and their risk appetite.
The glass ceiling in alternative investments
Advisors, do you know your clients' real risk appetites?
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