Spectrem Group reports in a new white paper that investors’ description of their risk tolerance has limited correlation with how they make investment decisions or how their portfolio is constructed.
Advisors, the paper says, need to develop the kind of personalized relationship with existing and potential clients that allows them to get around traditional words used by the industry to describe risk tolerance and understand their clients’ needs, time horizon and overall personal philosophy.
Other recent research also addresses the advisor-client relationship:
- How to close the gap between what advisors offer and what wealthy clients want
- How to bring value to clients now — and prosper as a firm
Spectrem fielded an online survey of 1,865 investors, 893 with a net worth of $1 million or more (137 had a net worth of $5 million or more) and 972 with a net worth of less than $1 million, not including their primary residence. In addition, Spectrem interviewed the $1 million-plus investors, half of who had more than $5 million in net worth.
A recent study showed that the number of U.S. households with at least $1 million in investable assets grew by more than 1.3 million since 2006 to 6.8 million households by mid-2016, accounting for 5.5% of all U.S. households.
The research found that the desire to preserve capital was a key distinguishing factor in defining an investor’s true risk tolerance.
In addition, conservative investors generally had a shorter investment horizon and so were less open to volatility. Age and investment time horizon were linked to risk tolerance, the research showed, but were not dependent on each other. Many younger households also had a short time horizon.
Fifty-seven percent of investors described themselves as moderate in terms of risk tolerance, while 20% each said they were conservative or aggressive.
Perhaps counterintuitively, more millionaires considered themselves conservative than non-millionaires, and more of the latter considered themselves aggressive than did millionaires.
Investors 54 and younger were likelier to describe themselves as aggressive or most aggressive, while older investors were more likely to say they were conservative or moderate. And women were likelier than men to describe their risk tolerance as conservative or moderate.
Whatever their self-descriptions, investors were more likely to consider potential losses than potential gains when making an investment decision.
Spectrem concluded from its review of data found that investors were unable to define their risk tolerance in terms commonly used by the advisory firms and financial advisors. Each definition of “conservative,” “moderate” or “aggressive” was different, it said.
What recourse, then, does an advisor have in helping a client if he or she cannot simply ask about risk tolerance.
Following are six things Spectrem said advisors should consider in working with clients:
1. Time horizon is not necessarily retirement
Although investors become more conservative as they approach a time horizon, that may not be retirement. Don’t presume that the investor plans to save until retirement, then start to withdraw money from his or her portfolio. He or she may need money sooner for an emergency or a discretionary purchase.
2. Is glass half empty or half full?
An individual’s personality influences risk tolerance. A generally optimistic person is more likely to be more comfortable with aggressive investments. For an understanding of how the client might assess an investment risk, ask his or her views on a situation outside the context of an investment.
3. Growth vs. capital preservation
The research showed that having a blend between capital preservation and growth was important to all investors in the study, especially to those who described themselves as moderate. Identifying the point where the change to preservation overcomes growth interests is key to understanding the client.
4. Self-identified conservatives
Spectrem says advisors should not try to convince conservative investors that the economy is recovering, or push them toward investments they are not prepared to accept.
5. Aggressive, but …
Even self-described aggressive investors own some fixed income investments, the study found. This may come from a desire to be properly diversified, or be part of the client’s tension between seeking return but preserving capital.
6. International investments
Be sure to introduce self-defined aggressive investors to international investments, as the data showed that a chief difference between them and conservative investors was an interest in overseas investments.
— Related on ThinkAdvisor: