Your clients are living through wild market gyrations and uncertain times. For most, their risk tolerance won’t have changed. However, their risk capacity may well have changed, so it’s a good time update their overall risk profile.
FinaMetrica has been measuring financial risk tolerance all around the world for more than 20 years, with around 1.5 million tests completed in all sorts of market conditions including market booms, crashes, and recessions.
From that experience, and data, we know that risk tolerance usually remains stable over time, regardless of market conditions.
Despite the wins, losses and scares that investors experience along the way their personality tends to stay the same – and financial risk tolerance is a measurable personality trait. Over the years we’ve done a lot of research and analysis and all our work confirms that risk tolerance does stay the same for most people.
Let’s look back to the market crash of 2008 and see what happened – or rather, didn’t happen – to the average risk tolerance (the light blue line) as the market crashed (the dark blue line):
As you can see, the average risk tolerance did not drop during the market bust – just as it did not rise to match the preceding boom or the one that followed.
People’s psychological profile stayed the same as events around them were changing, with a very small number of exceptions. We know from our research that, in rare cases, risk tolerance can change if someone experiences life-changing events of enormous magnitude and significance – so big, that their basic psychology is altered.
We may be living through events of that magnitude and significance right now, at a scale we have not experienced before, so it is well worth re-testing clients’ risk tolerance. Most will be unchanged, but you could uncover some of those exceptions in your own client-base. If you do, their plans need to be revised.
Meanwhile, all clients need a revision of their risk profiles – as while risk tolerance will not have changed for most, the risk capacity for many could be very different. After the wave of market corrections, shutdowns, and job losses many people will find themselves in a different financial position to just a few months ago.
It’s time to get to know your client again! Major changes, such as those underway now, can urgently bring changes to people’s:
Work and/or retirement situation
Many jobs are being lost, which can be devastating for older workers who are often not reemployed in a recovery, tipping them into involuntary retirement. Meanwhile, those in employment but suffering investment losses may now be considering delaying a pending retirement to rebuild their resources.
Goals and priorities
Yesterday’s goals may still be intact for some, but they will have changed for others. You need to know when clients are going through these changes and help them sort through their priorities in this new environment.
Financial resources and capabilities
Market losses, economic shocks and mass unemployment have hit simultaneously – it is the blackest of black-swan events and its effects are widespread. For some, their capabilities may no longer support their goals and important discussions will flow from that. Retirees may find that their current income is unsupportable.
When it comes to investments clients will, understandably, be emotionally rattled by these events. Some will want to cash-out investments to avoid further losses, although this group will be smaller for advisors who invest clients according to their risk tolerance and frame their investment expectations to prepare them for this type of volatility.
The FinaMetrica Risk and Return guides are useful tools to assist you with these framing discussions – there is a guide to using them in this month’s newsletter.