Horsemouth: “Managing the Biggest Risk: Client Behavior”
November 12, 2020, Horsemouth — In today’s issue of Horsemouth, reporter James Picerno writes, “The wild card in any client’s investment risk profile is how well they will handle loss, and that can be devilishly hard to predict. However, starting relationships right can help keep client behavior manageable later.”
He turned to Marguerita Cheng, CFP® and CEO of Blue Ocean Global Wealth Management to discuss “how clients will tolerate less.”
Rita explained: The wild card is behavioral loss tolerance (BLT). What makes this aspect of client risk profiling so difficult is that it’s almost entirely depending on individual personality characteristics—characteristics that may be devilishly difficult to assess, much less manage. As the CFA Institute’s primer reminds, this aspect of a client’s IRP “can upset the most carefully devised quantitative portfolio strategy.” There are no short cuts to avoid this risk, but there are best practices for keeping the threat to a minimum.
The toolkit includes identifying areas for trouble with clients early on and being proactive so that misguided ideas and expectations don’t fester and derail an otherwise well-designed plan.
“As much as clients are interviewing advisors, we’re interviewing them,” says Marguerita Cheng at Blue Ocean Global Wealth. The goal, she explains, is to identify and favor clients who are aligned with her financial planning and investment management philosophy to avoid trouble later on. Sidestepping personality types with a preference for short-term trading, for example, is a red flag, she says.
Like a growing number of advisors in recent years, Cheng prescreens potential clients with several techniques, including conversations and asking investors to complete a risk-profile questionnaire. “I use Riskalyze for every client who comes in the door,” she says.
Cheng is far from alone in deploying Riskalyze (or its various competitors) to parse client preferences and predispositions on matters of risk. Like many advisors, she uses the information as a baseline for measuring relative changes. Although the initial score can be useful, the ability to monitor how a client’s profile changes through time provides valuable insight.
“I want to understand your risk number and your capacity for risk,” she explains. “It’s also helpful for couples. You may have one risk number and your spouse has another.”