Intern JP Arnold’s Research on Accurately Assessing Client Risk Tolerance

Accurately assessing a client’s risk tolerance is important for a wealth management firm to appropriately identify an appropriate portfolio for its clients.  Currently, Acumen Wealth Advisors performs this process through a highly personal and familiar approach.  Each question is tailored to the client and delivered through conversation, so the clients may be at ease and answer honestly.  It is important to understand how risk works and how people react to it, so our team may employ the best possible method to assess and record a client’s tolerance to risk on the Investment Objective Form.  Often, when people are presented with losses beyond their comfort zone, they will react irrationally and may end up losing more money because of that.  A wealth advisor’s responsibility is to work with the client to try to prevent this behavior from happening.

Financial risk tolerance is the maximum amount of uncertainty someone is willing to accept when making a financial decision (Grable, 2000).  Typically, higher risk means there is a higher uncertainty and possibility of loss, but, as a reward for incurring higher risk, there is a possibility greater profits could be made on these investments.  Different people have different risk tolerances based on their personal preferences, education, and past experiences.  Since everyone has a different appetite for risk, it is important to accurately assess risk of clients properly.  Often, people deal with risk irrationally.  In the book Beyond Greed and Fear, Shefrin talks about how perceptions of risk and return are highly influenced by how decision problems are framed (Shefrin, 2002). For example, a client may be okay losing 10% of their $100,000 investment.  But if you turn the percentage into its value of $10,000, they may not feel as comfortable.  Because risk tolerance fluctuates so much, it is a difficult process trying to pinpoint an amount.

There are many variables resulting in a person’s risk tolerance.  They all fall under two categories:  risk capacity or risk preference.  Often, they do not match.  A person’s risk capacity is “how much risk a client can afford.” (Brayman, 2012).  Risk preference is more emotional.  It is the amount of risk they want to take.  A person’s risk capacity is often lower than their preference.  Risk capacity is typically measured by variables such as age, location, health, etc.  They are typically variables relating to a person’s incomes and expenses.  This risk capacity is because they do not want to invest too much so, if there is a loss, it will affect their ability to pay their expenses.  Therefore, people with more job security, less expenses, and a higher disposable income will typically have a higher risk capacity.  This factor is important because, if a client had higher capacity than their preference, then they will not be maximizing their potential gains. But, if they had higher preference than their capacity, they could end up bankrupt if there is another economic crash. A wealth advisor’s job is to determine the client’s capacity and their preference.

We believe the approach Acumen currently takes is very important and, using additional resources will help place a client more accurately into one of the customized models. Essentially, risk preference would be gauged by an advisor and risk capacity would be calculated by additional formal questions.  The questionnaire will be incorporated into our Investment Objective Form.  A client’s recent experiences with risk will affect how they perceive it now (Shefrin, 2002).

In conclusion, it is important for a client’s risk tolerance to be assessed accurately so a wealth advisor may offer the best advice for the client.  We believe these changes will ensure Acumen is able to assess our clients risk score as accurately as possible, so we may serve them in our best capacity.


Works Cited

Brayman, S.  (2012).  Defining and measuring risk capacity.  Financial Services Review, 131-148.

Grable, J.  E.  (2000, June). Financial Risk Tolerance and Additional Factors That Affect Risk Taking in Everyday Money Matters.  Journal of Business and Psychology, 14(4), 625-630.

Shefrin, H.  (2002).  Beyond Greed and Fear.  Oxford University Press.


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