Risk is not an absolute. It is ever changing with many shifting variables. That is why risk is so hard to succinctly and accurately verbalize with most investors not knowing how to express their very personal feelings about risk or even wanting to discuss their changing perceptions of it. Rapid advancements in technology and data analytics are helping to create new solutions on how to approach risk measurement with clients.
It is for this reason the Institute for Innovation Development sought out Institute member Larry Shumbres, CEO of Totum Risk—a FinTech company that provides a unique risk tolerance tool that is constantly adding new technology and approaches to the client risk measurement quandary for advisors. He shares with us what he sees as transformational strategies for more holistic risk management measurement and the risks of not adapting them.]
Bill Hortz: What do you see as the biggest risks in risk management for advisors in today’s environment?
Larry Shumbres: My concern is that, especially as economic and market risks seems to be climbing, many advisors are not accurately assessing their client’s risk profile. Inaccurate, confusing and outdated investment risk assessments pose a major business risk for them. Most risk assessment tools are based on a client’s feelings about risk, not how much risk they can take given their current life situation. It’s important to use a risk tolerance tool that calculates risk capacity which also has a metric, in addition to risk preferences. Then you can compare the scores in order to accurately assess the right amount of risk for your client’s current stage in life. Advisors also need to be wary of risk tolerance tools that do not utilize in-depth algorithms to incorporate more client data to calculate the risk score. Using the wrong product could be a costly mistake that can potentially lead to arbitration.
Additionally, most advisors give the questionnaire only once. If you use risk measurement questionnaires, they need to be given at least annually. Assessing your client’s multidimensional risk profile on an ongoing basis helps advisors better guide them to reach their goals, even through a bear market.
Not only does this better frame the investment strategy, it’s also a great way for advisors to reinforce their client relationships. In an era when people deviate from their parent’s financial advisor in favor of robo-advisors and their own personal networks, any opportunity to connect with clients is a plus.
Hortz: What do you recommend are important questions that advisors need to ask about their risk measurement process at this junction in the market?
Shumbres: I highly recommend that advisors take a fresh look at their risk tolerance tool. Does it calculate risk preference, risk capacity, or both? Does it cover the new SEC BI rule? Is it truly a risk tool or a prospecting tool? Has their risk questionnaire been tested during a market cycle or was it copied into a bull market? Is the questionnaire easy to take? When was the last time their clients took the questionnaire? Will it protect them in arbitration?
Hortz: Based on your research, what have you been uncovering that is important to note in regards to client risk measurement issues today?
Shumbres: In our latest research we found 65% of investors are taking a risk tolerance questionnaire via their mobile phone, so it is important that the risk tool be mobile friendly. We also found from talking to clients that most risk questionnaires are difficult for them to understand, so investors are guessing at the answer which negates the accuracy of the score. Academic research claims that a person or household has one major life event annually that will impact their investment objective. Question then becomes: Is your client risk measurement process and risk tool you are using capturing those life events on a regular basis?