Investments always require some degree of risk tolerance. However, as a financial advisor, you’re in an excellent position to help clients identify risks, assess their potential impacts and explore the most effective and appropriate mitigation strategies. Then, clients have the best chances of maintaining asset security while facing risks within and outside their control.
Gauge the Client’s Risk Attitude
Understanding how your client feels about risk can help you guide them in making tailored decisions about their financial investments. Risk attitudes can vary based on factors like:
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The client’s exposure to risk before adulthood
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Current and historical levels of risk in their life
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The client’s family situation
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The client’s personality
A 2023 study of investors in six European countries also found gender, wealth and salary also play a role in shaping risk attitude. However, the researchers determined investment experience and financial knowledge were even more important.
You can categorize risk tolerance in one of three ways:
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Risk-seeking: People who enjoy taking risks because they tend to focus on the anticipated benefits rather than the potential unwanted consequences.
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Risk-averse: Those in this group prefer certainty, even though prioritizing it may result in fewer rewards than a riskier approach.
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Risk-neutral: A risk-neutral person likes to weigh all the pros and cons before deciding what to do, and is usually highly calculated in their thought process.
Understand Personal or Familial Circumstances
Changes in someone’s life can also affect conclusions made during a risk management audit. Perhaps your client is planning to have their first child or has just learned their employer has an aggressive layoff strategy affecting their department or team.
Those factors may cause a client to desire a less risky investment strategy, even if they generally don’t mind taking significant risks. Clients may need to discuss proposed investment opportunities with spouses or other affected family members.
Categorize Risks and Associated Controls
Even when people do everything possible to mitigate risks, life is still full of plenty of surprises. An important part of the risk management audit is to help clients control what they can while being as prepared as possible for the factors over which they have no or little influence.
For example, your client may protect their finances by being extremely strict about the percentage of their income used for investing. That’s a practical control that can help people invest confidently while ensuring they have enough to cover living expenses and unexpected needs.
However, aspects such as economic volatility can increase a client’s risk more than expected and limit their control over what happens. Many people diligently study the stock market and look for signs of potential trouble, but some crashes and other events come as near-total surprises.
Spend time during the risk management audit helping clients account for the most significant risks within and outside their control. Group the risks according to the level of control a person can exert to mitigate them. Finally, look at all those over which a person has little or no power to influence. Have the client consider the potential impacts on their lives if some of those worst-case scenarios occurred.
Encourage them to think about future rulings or laws that could ultimately affect their investments, too. For example, the U.S. is progressively working on cryptocurrency regulations that other nations will likely treat as frameworks to follow. If your client has cryptocurrencies within their investment portfolio, any regulations coming down the pipeline might affect some decisions.
Clarify That the Audit Is a Positive Event
Many people view audits as evaluations they never want to experience. If someone makes income far above what’s expected for their industry or has recently publicly admitted to experiencing unprecedented growth, those factors could trigger auditors to take a closer look at the person’s finances to ensure all is in order.
However, you must aim to reshape your client’s potential negative perceptions surrounding audits. Discuss how the more you know about risk management details, the better you can suggest strategies to grow and protect investments.
Talk About Current Feelings and Expectations
Assessing how your client feels about their life, investments and prospects will help you build a strong foundation for risk management and mitigation. The results of a June 2023 survey found business owners would appreciate input from financial advisors on various topics.
Inflation was the top concern, with 88% of mid-sized business owners and 71% of those with small organizations wanting assistance navigating that challenge. Rising interest rates were also significant concerns and cited by 87% of mid-sized business owners and 67% with small companies.
Despite those challenges, 74% of respondents with medium-sized businesses and 55% with smaller organizations consider their company-related outlook as good or excellent. As a financial advisor, you’re in an ideal position to help clients capitalize on upturns while reducing the impacts of various risks.
In addition to talking to clients about how they’re feeling now, find out what they’d like to achieve investment-wise within the next six months to a year. Plan to do this after completing your risk management audit so it’s easy to look at your assessment results while listening to the client’s aspirations.
Risk Management Audits Provide a Clear Picture
Knowing how financial risks would affect your client and how prepared they are to handle them will give you the specific information needed to guide their future financial decisions. These assessments take time and dedication, but they’re worthwhile for understanding the intricacies of your client’s situation and how to maximize their investment strategy outcomes.