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Assessing a Client's Risk Tolerance: Don't Think You Can Set It and Forget It

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Over the years there has been a great deal of discussion pertaining to the topic of determining a client’s tolerance for assuming risk. Questionnaires abound as advisors seek to understand this most abstract of topics. How much risk is a client willing to assume? That depends. Is there a questionnaire that will provide advisors with an absolute answer? Perhaps, but I have never found it. That said, we still have an obligation to our clients in this area.

I had an interesting interaction with a particular client during a recent account review that I’d like to share. When I first met this client earlier this year his portfolio was 100% in cash. He filled out the obligatory risk questionnaire and his profile matched that of an aggressive investor. In fact, one of the questions asked what he expected his portfolio to return over the next five years. Guess what his answer was? 10%+! That raised a red flag for me. I was obviously concerned that his expectations, especially after what transpired in 2008, might be a little over the top. I was also curious how a person with 100% cash was bullish enough to expect to average more than 10% over the next five years. We have since talked about it and his response made it clear to me that this was not going to be an issue.

Many people believe that because of the horrific decline in the stock market we’ve experienced investors will be more fearful for quite some time. While I believe this may indeed be the case, it may also be short lived because the markets have risen so dramatically since their lows in March. It’s true that when stocks are soaring, investors get greedy and when stocks are sinking, fear takes over. The point is that accessing a client’s risk tolerance today would yield a very different result than in late 2008 or at the height of the bull market in 1999. Investors’ risk tolerances clearly change based on their expectations, which in turn are based on their emotions at any given moment.

Since an individual’s risk tolerance is such a fluid topic which changes with prevailing market conditions, we, as advisors, need to reassess it on a regular basis.


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