Risk. It’s a tiny word for a critical investment concept, one that necessarily merits ample discussion by advisors with their clients. Unfortunately, evidence suggests this may not be happening evenly across the advisory industry. According to a recent study by YCharts, an investment research and proposal-generating platform, more than one-third of survey takers say their interactions with financial advisors are infrequent or rare, despite nearly 90 percent of these same respondents citing their strong preference for only working with advisors who communicate on a frequent basis. A study conducted by FinMason, an investment analytics firm, shows that advisors to 75 percent of respondents did not inform their clients about the kinds of risks that can decrease portfolio value during volatile periods.
As savvy financial advisors know, building long-term client relationships requires transparency and interactive dialogue. You can’t build trust with your clients unless they feel you are in their corner. Risk is a complex and somewhat unglamorous topic. It’s hard to talk about risk without accounting for the type of client you are attempting to assist. A risk-based financial plan for an individual reflects an investor’s age, health, income, family size, and lifestyle preferences. In contrast, institutional investors analyze risk factors such as funded status, interest-rate levels, workforce demographics, plan design, and spending requirements.
An effective process commences with identifying risk factors
When Dr. Ronald Sages, AEP, CFP, CTFA, EA, a portfolio manager and director of behavioral finance with Eagle Ridge Investment Management, sits down with his high net worth and personal trust clients, his first job is to understand what they want to accomplish. As he explains, “My clients worry about having sufficient resources to live comfortably in retirement or how best to structure their estate plans to fulfill personal and philanthropic objectives. We don’t talk about tracking short-term ebbs and flows in the stock market.”
This redefined focus on risk as a function of client goals is a concept Sages reinforces in the classroom as an adjunct professor at the University of Georgia, College of Family and Consumer Sciences.
Kenneth Chavis, IV, CFP, is a senior wealth advisor at Versant Capital Management and helps business-owner clients optimize their portfolios in a fiduciary capacity. His conversations center on how differing levels of risk may either detract or support them in achieving their stated long-term goals. He notes, “We strive to educate every family we serve on risk and market volatility. We conduct long-term scenario analyses based on varying portfolio risk and return profiles.”
Chavis describes this goal-centered process as a cornerstone of his company’s approach, adding, “We construct portfolios with the least amount of risk we think is needed to help each client achieve their long-term goals.” He references risk-tolerance tools like questionnaires and surveys, along with the CFP Board’s content about investment planning and risk.
When Michael Clark, FCA, MAAA, FSA, EA, CFA, the chief commercial officer at Agilis, discusses risk with his company’s retirement plan clients, regulations like the Employee Retirement Income Security Act (ERISA) are a core part of the agenda. A Fellow of the Society of Actuaries, Clark elaborates, “It’s not just financial risk that concerns the institutions we help. We need to help them determine whether their fund lineup – the investment choices they offer plan participants – is competitive from a fee and performance standpoint. Otherwise, they are subject to fiduciary risk and, by extension, litigation risk.”
David G. Pitts, FSA, MAAA, is the owner of Independent Actuarial Services. He emphasizes longevity risk as a ticking time bomb for both individual and institutional investors. With the help of co-author Dr. Susan Mangiero, Pitts created a literature search about defined benefit risk communications at the request of the Society of Actuaries. It includes sample risk policy statements, risk governance structures, and lessons learned about global retirement plan management.
Pitts also conducted a series of stakeholder interviews with experts ranging from CFOs to actuaries about risk management and mitigation. He urges advisors to address the liability side of the equation, stating, “Advisors must ask clients what they think they will need in the event they live longer than expected. Don’t forget to ask your individual or institutional clients how they plan for deteriorating health. One setback can cost a fortune.”
You can’t manage risk unless you measure it
As documented on the CFP Board’s website, measuring risk in both qualitative and quantitative terms is an essential element of dealing with various types of risk, including interest-rate risk, credit risk, inflation risk, liquidity risk, reinvestment-rate risk, foreign currency risk, and political risk. While it’s tempting to churn out brightly colored charts and tables from reams of data, financial advisors may upset clients who favor plain language over information overload and excess jargon.
Sages says, “It’s rare I have conversations with clients about standard deviation, the Sortino ratio, and the alphabet soup of basic risk metrics. My clients measure risk in terms of dollar losses that, if realized, thwart their abilities to protect their families.”
Chavis worries that too many investors think of risk as esoteric. He suggests, “Keep things simple and high-level. Make it real and tangible to people. A good approach is translating risk statistics like standard deviation into dollars in lieu of presenting only percentages. Personalize whenever possible.” An ardent supporter of financial literacy, Chavis began tutoring his four-year-old daughter in budgeting and saving two years ago.
Pitts advocates for an integrated approach to risk-based financial planning that includes serious talk about decumulation. He understands that diverse kinds of investors measure risk differently. Pitts continues, “One person defines risk as a checking account with a low balance. Another person defines risk as not being able to fly business class or take an extra vacation. Yet another may view risk in terms of resources for long-term care.” He recommends advisory discussions that reflect an integrated approach to risk, one that considers both traditional financial vehicles and nontraditional risk mitigation approaches.
Clark’s discussions with investment committee clients reflect their statutory duties to prudently manage investment risks. “We help our clients interpret investment risk – especially our defined benefit plan clients since they typically bear all of the financial risk – by benchmarking against appropriate asset and liability indexes,” he says.
“We review whether, and to what extent, a third-party asset manager has strayed from an agreed-upon mandate. We look at what drives funded status up or down,” Clark added.
Clark is a proponent of stochastic modeling, concluding, “It’s not enough to understand our clients’ risk tolerance levels. We must show company decision-makers how dreadful things can get if X, Y, or Z occurs.”
The discussion about risk never ends
As the accompanying table about financial planning and risk illustrates, identifying risk factors and measuring them is just the beginning of a financial advisor’s discussion with a client. Taming investment risk is an ongoing process. Once identified, investors, with the help of their advisors, must rank risk factors. Once measured, the process proceeds to manage those risks. Once managed, each investor must monitor their risk/return profile.
Paying attention to risk never ends – nor should it. Financial advisors have a vital role to play in helping their clients properly invest in the long term by recognizing the inextricable relationship between risk and return.
After a productive career as a Wall Street trader, testifying investment expert witness, and university professor, Susan Mangiero, Ph.D., CFA®, MBA, MFA currently works as an independent financial journalist, ghostwriter, and content strategist. Her articles, books, and thought leadership work appear in more than 100 business outlets.
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Risk. It’s a tiny word for a critical investment concept, one that necessarily merits ample discussion by advisors with their clients. Unfortunately, evidence suggests this may not be happening evenly across the advisory industry. According to a recent study by YCharts, an investment research and proposal-generating platform, more than one-third of survey takers say their interactions with financial advisors are infrequent or rare, despite nearly 90 percent of these same respondents citing their strong preference for only working with advisors who communicate on a frequent basis. A study conducted by FinMason, an investment analytics firm, shows that advisors to 75 percent of respondents did not inform their clients about the kinds of risks that can decrease portfolio value during volatile periods.
