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April 20, 2015 at 10:44 AM
Advisors typically begin client relationships with a focus return on investment but a new white paper argues that, paradoxically, an emphasis on risk is the surer path to keeping clients happy and winning over new prospects.
The essential problem, according to the paper by Riskalyze, is that while clients seek out advisors because they’re looking for a return on their investment, advisors who cater to that interest in ROI end up setting up expectations that no advisor can ever truly meet.
“Our industry typically focuses on the performance of a portfolio based on the average — a tactic that all but guarantees failure — leading to countless hours of phone calls and meetings with worried or unhappy clients that could have been avoided simply by setting better expectations up front,” the white paper states.
Auburn, California-based Riskalyze, whose questionnaires advisors use to generate a “risk number” that aligns portfolios with risk preferences, argues that advisors and their clients are mathematically doomed if the expectation is to achieve some vaunted average return.
“Unless you are invested completely in bonds, it is unlikely for the returns on a portfolio to be within even 5% of its average,” says the white paper, along with an accompanying table showing poor prospects of nearing average portfolio returns based on varying standard deviation scenarios.
The result is likely to be mutually unwanted “talk me off of the ledge” conversations during market downturns.
The white paper is not shy about explaining the advantages of its author’s product to sidestep the problem.
The Riskalyze questionnaire has become a popular tool among a segment of advisors as a means of generating a “risk number” that lets clients quickly visualize whether their current portfolio matches or fails to match their risk preferences.
As opposed to products that are based on either psychological testing or age-based stereotypes, Riskalyze’s quantitative based questions use the actual dollar amounts the client has to invest.
The client then specifies what percentage he is willing to lose (say 13%) over a six-month period in order to gain the chance to make a certain amount (say 20%) over the same time period.
