June 30, 2011

Mars and Venus: Helping Client Couples Resolve Conflicting Risk Tolerances

It is your first meeting with new clients, Bill and Suzie. At some stage, probably quite early, risk tolerance will come up for discussion. You know that while Bill is probably more risk tolerant than Suzie, it is quite possible that Suzie is the more risk tolerant of the two. You also know that quite often there is a significant difference in risk tolerances within a couple and that this can be a problem that you will need to help them resolve. Before looking at how you might do this, let's look at the statistics about within-couple differences.

At FinaMetrica, when we extract couples data from our database of more than 400,000 risk profiles, the within-couples picture looks like this

               Mean                    Standard Deviation

Males:                  61.0                        12.3

Females:              54.0                        12.1

(The 0-100 risk tolerance scale used for these measurements has a mean of 50 and a standard deviation of 10.)

This means that in 66% of couples, the husband is more risk tolerant than the wife and, obviously, in 34% the wife is more risk tolerant than the husband. However, in terms of finding strategies with which both will be comfortable, the question to ask is not which of the two is more risk tolerant but rather whether there is a significant difference in their risk tolerances. Here it is a question of degree and it would appear that anything more than a standard deviation, 10 points on the scale, deserves consideration.

The statistics tell us that in 60% of couples there is a difference of 10 points or more. Where there is a difference of this magnitude, the wife is the more risk tolerant of the two, slightly more than 25% of the time.

Investment Implications of Mars and Venus

To put this in perspective from an investment strategy point of view, one point of risk tolerance is roughly equivalent to 1% of stocks in an investment

portfolio. So if Suzie's risk tolerance score is 60 she can be expected to be emotionally comfortable with a 60% stocks portfolio. If Bill’s score is 50, that would indicate comfort with a 50% stocks portfolio. Of course with a mapping like this we are talking more about comfort zone ranges rather than a specific point of comfort because portfolio volatility is not highly sensitive to the percentage of stocks in a portfolio.

If Suzie's risk tolerance means that she will be comfortable with a 60% stocks portfolio, then she is also going to be comfortable with 61%, 62%, 63% and so on, with the emotional upper limit being around 70% stocks. However, if Bill and Suzie need a 70% stocks portfolio to achieve their goals, while this would be marginally okay for Suzie, it would certainly take Bill outside his risk comfort zone.

More extreme differences--of 20, 30 and even 40 points--do occur, perhaps as a result of an attraction of opposites, and the more extreme the difference the more probable it is that the husband is the big risk-taker. Extreme differences make life difficult for a couple acting jointly and, by extension, for their advisor. Imagine such a couple whose scores are 70 and 30, two standard deviations above and below the mean respectively. It is going to be quite a challenge to find a strategy which suits them both.

The Beginning of a Solution, and a Warning

The starting point for resolving Mars and Venus risk tolerance mismatches is to recognize that the clients ‘own’ the problem. The advisor's role is to suggest and illustrate possible solutions, to guide and mentor, but not to decide. A couple acting jointly may decide to go with the lesser of the two, the greater of the two or somewhere in between. Alternatively, if one of them is very much the financial decision-maker they may go with that person's risk tolerance. Regardless, each needs to understand the risks involved in any strategy and how those risks compare with their individual risk tolerance.

In some cases, structuring portfolios to reflect the dynamics of the couple may help. For example, where a couple is looking to adopt a strategy more

in line with the lesser-risk-tolerant of the two, some portion of their assets may be placed into a high(er) risk portfolio which can be seen as "belonging" to the more risk tolerant of the two.

One particular Mars and Venus situation is quite dangerous. Here, the husband is far more risk tolerant than the wife and has primary responsibility for the family's financial affairs but is not, in fact, the stronger of the two. A further complication may be that the husband is overconfident which is likely because overconfidence correlates with risk tolerance. Everything goes smoothly until the market dives, at which stage the wife steps in either behind-the-scenes or overtly, and, applying her risk tolerance to the situation, demands a bailout. Something similar can occur even when the wife is not the stronger of the two if she becomes sufficiently distressed by what is happening and the husband feels obliged to sell to preserve her emotional state.

The lesson for advisors is that with any couple there must be separate, defensible risk tolerance assessments for each and that it is critical to obtain the informed consent of the less risk tolerant to the risks inherent in a recommendation before it is implemented.

Couples will nearly always know which is the more risk tolerant of the two but they usually won't know the magnitude of the difference nor where it arises. Perhaps more importantly they don't know whether the more risk tolerant in the couple holds average risk tolerance with the less risk tolerant being below average. Or, the more risk tolerant may be above average with the less risk tolerant being average  - and these are two quite different situations.

It is not uncommon to find a risk-seeking, overconfident husband who has persuaded his quite average wife that he is in fact average and she is timid. This is where a robust, information-rich risk profiling system is of great assistance to advisor and client, and can lead to some very interesting discussions. One of our U.K.  subscribers reported a wife as saying "My husband's score was so high we decided he shouldn't be allowed to make any decisions by himself."

It is always valuable for the client and the advisor to have an accurate understanding of the client’s risk tolerance. It is particularly valuable when dealing with significant differences within a couple and helping the client first come to terms with this and, second, finding a way to deal with the disparity. Assuming you conduct your risk tolerance in the early stages of your engagement with the client, this ability can also serve as a very early demonstration of the advisor’s expertise.

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