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Assessing Clients’ Risk Tolerance Now With Geoff Davey of FinaMetrica: Weekend Interview

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“Client risk tolerance doesn’t change as the markets go up or down,” says Geoff Davey, one of the acknowledged experts on the topic. Answering a question about whether Davey’s FinaMetrica risk tolerance software might help advisor users identify specific clients with whom advisors should be communicating during this current volatile period, he suggested the question reflects a flawed understanding of what his technology reveals about clients and prospects.

“People with lower risk tolerances should be in lower-risk portfolios” already, he said in a Wednesday interview with AdvisorOne in New York, the night before he was scheduled to fly back to his native Australia after a multi-week visit to the U.S. “What’s happening in the markets now,” he said in reference to events in Japan, North Africa and the Mideast, shouldn’t be of particular concern to lower-risk-tolerant clients, since they should already be in low-risk portfolios.

Davey spent 20 years as a financial planner in Australia, building a large planning firm before selling that company, co-founding FinaMetrica in 1989 and developing its Web-based risk-profiling system. Were he still a planner today, he says that beyond talking to clients with low risk tolerances, he would be “communicating with every client.” The problem, he argues, is that clients watch CNBC or read newspapers and “hear that the market has fallen,” and jump to the mistaken conclusion that said “falling market” has affected their personal portfolios.

Assessing risk tolerance, Davey says, is “more important in getting the [portfolio] strategy right in the first place” and in then informing how the advisor communicates with the client, so that “you’re referencing and reinforcing what you’ve already discussed” with the client. There’s a deeper problem as well, he argues, that causes problems further down the advisor-client relationship road: many clients are taking steps that their advisor has recommended, but they don’t understand the ramifications of those steps.

To illustrate the problem, Davey uses a medical analogy. If you go to an orthopedic surgeon who’s recommended a knee replacement, he will tell you that the operation will likely be successful, but that you’ll experience pain, serious pain, for up to 12 months. Wanting to take care of the presenting medical condition, the patient may not fully appreciate the level of pain and the amount of grueling work that is necessary to rehabilitate that knee after the surgery. Davey suggests that the advisor’s role is not

simply to set up a financial plan—which he says only has a “half-life of, what, three years?”—but also to educate and reinforce the goals of the plan and the steps—including but not limited to the investments—that will help the client achieve that plan's goals.

Davey recommends that his advisor clients—the biggest users in the U.S., he says, are ‘NAPFA members, AICPA PFPs and Dimensional [Funds--DFA] users—perform risk tolerance assessments using FinaMetrica’s 25-question Web-based questionnaire, but also rerun the test every few years, as end clients’ personal situations and goals develop.

(For more on how FinaMetrica works, see this article by AdvisorOne's Kathleen McBride.)

When clients or prospects take the questionnaire, it not only provides the client’s advisor with a risk tolerance score for that client, it also compares that score with the client’s self-assessment of their risk tolerance, providing the advisor with salient talking points for the relationship and for portfolio construction. Client couples take the test separately, the results of which, Davey drolly notes, often makes for “interesting discussions” between the couple, not to mention providing their advisor with better clarity on the couple’s often differing feelings toward risk.

(See Olivia Mellan’s November 2009 cover story for Investment Advisor on assessing risk.)

Davey says 80% of FinaMetrica’s business comes from three countries: the U.S., the U.K. and Australia. Why isn’t Japan a big market for FinaMetrica?  “Japan has many CFPs,” he says, “but few real financial planners.” Davey is also following Dodd-Frank implementation and the fiduciary issue in the U.S., and is particularly interested as well in how Britain’s equivalent of the SEC, the Financial Services Authority (FSA), is now leading the way in areas like fuller disclosure on advisor conflicts, on fees charged by advisors, and on where and from whom advisors receive compensation. “Financial advisors in the U.K.,” he points out, “cannot accept any commissions after January 1, 2013.”

For Davey, the issue in the U.S. if a fairly simple one: “What are you, the advisor, holding yourself out to be? Do you offer ongoing advice? If not, make it clear.” He makes a distinction between providing merely investment advice and comprehensive financial advice. “Decide if you are an investment advisor or a financial advisor.”

(For more on communicating with clients, see the AdvisorOne editorial staff’s March 17 survey of what leading advisors are communicating to clients now.)