Determining a client’s risk tolerance is a standard requirement in financial services, both as a matter of best practices, and regulatory minimums. In recent years, though, advisors have increasingly leaned towards doing the minimum required to assess client risk tolerance, due to the frustration that client risk tolerance itself has varied wildly through the bull and bear market cycles of recent years.
However, a new study from FinaMetrica from before and after the global financial crisis joins a growing body of research suggesting that in reality, client risk tolerance is actually remarkably stable, and that what’s changing through market cycles is not the client’s risk tolerance, but instead risk perceptions. The significant implications of the research are that planners struggling with unstable client investment behaviors around risk—e.g., buying more in bull markets and selling out in market declines—may actually need to focus more on managing risk perceptions, rather than blaming the instability of client risk tolerance.
The inspiration for today’s blog post is a recent research paper entitled “Individual Financial Risk Tolerance and the Global Financial Crisis” by Australian academics Paul Gerrans, Robert Faff and Neil Hartnett. The authors looked at the financial risk tolerances of 4,741 investors before and after the global financial crisis in late 2008, using global investor data available from FinaMetrica, arguably the world’s leading (and most rigorous and scientifically validated) risk tolerance assessment tool.
Evaluating Risk Tolerance Over Time