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Revealing Risk Tolerance
The psychology of risk tolerance is a field many financial advisors more than dabble
in, whether they officially recognize it or not. While these advisors don’t wear white
coats, they do take notes and many do have comfortable couches – or at least cozy
chairs for clients – in their offices. Gauging a client’s willingness or ability to tolerate
risk is a significant skill for any advisor to master.
This is why John S.
Longstaff, CFP®,
one of six partners
with The Planning
Center, supports his
firm’s use of the Australian-based
FinaMetrica’s
Risk Profiling
System. Using 25 questions and psychometrics
developed by the psychology
department at the University of
New South Wales, the system provides
advisors and their investing clients
with a scientific analysis of a client’s
personal financial risk tolerance.
“This isn’t necessarily about how
much of their portfolio is in stocks or
bonds, or how putting 60 percent of
their investments in stocks and 40 percent
in bonds will affect them,” Longstaff
explains. “This is about assessing
ahead of time how they deal with risk
and its potential consequences.”
According to Longstaff, each individual’s
tolerance of risk is directly related
to their money history. He gives
the example of seating ten people
around a table and placing a $100 bill
in the middle of the table. “Each person,”
Longstaff said, “will have a distinctly
unique reaction to that $100 bill.
One might say that his father used to
light his cigars with a $100 bill. Another
may say that they never even saw a
$100 bill until they were age 40.” Those
two examples may represent drastically
divergent abilities for tolerating
risk when it comes to their individual
money history. They can also represent
different and potentially destructive
behaviors regarding the management
of that money.
“We attempt to assess for any destructive
behaviors up front. Then in
the consultative process, we work with
that client to change those behaviors.
They need to be willing to change –or
at a minimum acknowledge – these
said behaviors .”
Armed with the evaluation of a client’s
money history, Longstaff and his
associates are better able to deal with
the inevitable jitters that may arise in
various clients when turbulence in the
market makes it jump to peaks and
drop to lows.
This also helps when the evening
news makes a high-speed, low altitude
pass reporting market movement
without giving any specifics or analysis
of what the activity really means.
“The news anchors get on television
and tell the viewers things such as, ‘Everyone
who has a 401k in the United
States lost X amount today,’” Longstaff
said. “It isn’t accurate and it causes un-
THE SUIT MAGAZINE - JULY 2014