Kol Birke, a financial behavior specialist with the independent broker/dealer Commonwealth Financial Network, suggests that advisors develop a risk score for clients after discussing four topics with them: risk tolerance, goals, behavior, and investment knowledge. (In the case of a client couple, I would advise that you query each spouse separately about these issues.)
1. Risk tolerance. Birke feels that the more pertinent these questions are to the client’s situation, the more reliable the results will be. A sample:
If your goal was $100,000 per year for retirement, which range of possible outcomes would you choose?
o Worst case $60k – Best case $90k
o Worst case $80k – Best case $150k
o Worst case $50k – Best case $250k
2. Goals. By learning what your clients want to achieve, you can determine their risk capacity (how much they can afford to risk). If an important goal is underfunded, you might ask:
Which of the following three options would you choose? Are any unacceptable?
o Push back the timetable
o Lower the amount
o Fund the goal from another source
Birke also likes to ask, “If in the future you are not on track for a goal, would you like me to address that with you?” If the answer is “yes,” he follows up with “What’s the best way to bring that up so it feels like we’re working together?”
3. Behavior. “Here is where I would like to learn about their tendencies under stress, and what resources they can draw on to curb the panic,” Birke explains.
4. Investment knowledge. “Investment knowledge is highly correlated with knowing one’s own risk tolerance,” he points out. “So I would ask some questions like ‘What is a bond?’” This is useful to gauge how much education about investment risk a client needs–education that in turn can help them make wiser decisions.