Reuven Moshkovski Extra Credit – Econ 220

“Time for Another Look at Client Risk Tolerance”

Journal of Financial Planning - Feb 2009

This journal article examines how to best analyze a client’s risk tolerance,

especially given the crazy financial meltdown that occurred in 2008. It opens by outlining

the stereotypical case of the 2008 investor who amidst the crashing markets pulled all of

their money out of the markets and into cash. This was despite the fact that in a

questionnaire about risk, the client indicated that the client could tolerate a high degree of

risk tolerance. Given the historical nature of the stock market, a client managing his

retirement account should not sell-out of all stocks and bonds given this market volatility.

According to the Investment Company Institute, during October of 2008 investors

withdrew a record $127 billion dollars worth of US stocks and bonds out of mutual fund

holdings. In November, this number was $86.4 billion, still a huge amount. Obviously,

psychological factors did play a role in this sell-off. Financial planners and financial

advisors normally attempt to calculate the risk tolerance that a client possesses.

According to a survey of 331 Financial Planning Association Research group members

during of October 2008, less than 10% of clients of financial planners actually went

through with selling their stock.

The article then goes through the various approaches to measuring the risk

tolerance of a client. All financial planners agree that it is valuable to measure a client’s

risk tolerance. This is often done with an “RTQ” or risk-tolerance questionnaire, however

many planners question the effectiveness of these RTQs. Bert Whitehead, president of

Cambridge Connection Inc. believes that RTQs are dangerous and results will vary based
on the situation. According to Whitehead it is the responsibility of the advisor to

determine how much risk is appropriate for the client based on the client’s unique

situation. These factors include the age of the client, the amount of risk the client needs to

take to reach their goals, the amount of risk they are currently taking, and their other

financial responsibilities.

William Droms, a finance professor at Georgetown University also agrees that a 7

question written survey to measure risk is an obsolete method. He advises that planners

instead meet with clients face-to-face, and through these interactions make decisions as to

how much risk the client should be exposed to.

Conway Halsall, an independent contractor with Ameriprise Financial Services

Inc. takes another approach to RTQs. He has all clients fill out a third party generated

RTQ before their initial interview, and then reviews their responses in person to make

ultimate decisions about financial strategy. In explaining the concept of risk, he makes

the point to clients that they will usually be 10 to 15% either on the high side, or the low

side, of their expected 6% to 8% return. As an alternative, many advisors also create their

own unique form for clients to fill out. For example, Leslie Beck, owner of Beck

Investment Management LLC in Palo Alto, California developed her own shorter form so

clients would not feel as if they are doing work. She also made sure not to include any

questions that implied gambling in outcomes, as potential clients often resent such

analogies.

Potential problems with RTQs include not enough questions, off-topic questions,

or questions that the client can’t understand or can’t answer. Some financial advisors use

psychologist created tests that are more accurate at measuring risk tolerance. However,
the general consensus among financial planners is that a written survey combined with an

in-person interview is the most comprehensive way to measure a client. It is important to

keep in mind that measures of risk tolerance often vary with the market. When in a bull

market, clients will overemphasized their tolerance to risk, while in a bear market, clients

may underestimate the amount of risk they are willing to take.