Determining Your Client’s Ability to Take Risk
25 August 2016
A simple risk tolerance assessment questionnaire will provide you with some insight into your client’s willingness to take risk — but what about their ability? Financial risk management is a critical part of your job as a financial advisor, but you need to understand the working relationship between ability and willingness in order to do so effectively. By utilizing a premier risk tolerance assessment software, such as Tolerisk®, you will get scientific results about both the willingness and ability of your client to take risks with their investments.
But how do you determine your client’s ability to take risk? Our risk tolerance assessment software evaluates the following factors:
Current assets — These are the financial assets that the investor currently has available. It is important that the tax status of these assets is identified.
Monthly Savings — The amount of money being saved every month/year (prior to retirement) is important. The tax status of those savings should be catagorized as taxable, pre-tax retirement funds, or funds in a Roth IRA/401(k), and differentiated accordingly.
Capital expenditures — Most investors will have major capital expenditures that need to be considered in their risk tolerance assessment report. Capital expenditures might include paying for a child to attend college, a wedding or putting a down payment on a home. Capital expenditures may be identified as near-term expenses, or at any time in the future, as they are expected.
General Annual Spending — The investor and the advisor should work together to determine general annual spending amounts. After a budget has been created for the individual investor, the advisor also needs to take into consideration the impact inflation will have on general annual spending over time.
Rainy Day Funds — Emergency funds should be considered so that the investor has the appropriate level of low risk assets available in the event of job loss, which would likely necessitate dipping into savings for some period of time.
Capital Inflow — Capital inflow might include the sale of a business, an expected inheritance or the downsizing of a home. These can be important factors in an investor’s current risk tolerance assessment.
Retirement Income — Retirement income must be accounted for because it can have a significant impact on an investor’s ability to withdraw funds from their portfolio over the course of time. In addition to determining the amount and time frame for retirement income, the advisor also must consider the tax implications of the required minimum distributions from an IRA or 401(k) account.
The risk tolerance assessment software should produce a customized report that is ideal for that particular investor at that moment in time. Risk tolerance levels will fluctuate and vary based on a variety of factors; often, these reports are revisited time and time again. Each time, a personalized report will be generated based on a scientific approach to risk tolerance. This innovative solution inspires confidence in both the investor and the advisor, and it results in long-term relationships being formed between the two parties.
To find out more information about Tolerisk® and how it can improve your financial management business, contact us today.