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Do You Have the Right Tools to Measure Your Clients’ Risk?

Seven warning signs that it may be time for a change.

"Financial education pencils"

With spring upon us, it’s the time of the year to clean house and say goodbye to things that no longer “spark joy.” Spring-cleaning is equally important for good practice management, to ensure your processes and tools are still serving you well.

Assessing the suitability of your risk tool is a good place to start. An accurate understanding of clients’ risk tolerance is essential to giving advice that fits their needs.

Here are seven signs to help you evaluate whether you should keep your risk tool or let it go.

  1. Your clients aren’t engaged in the risk assessment process. If clients don’t find the process engaging, they may put less effort into it. While the purpose of the risk tool is to provide a deeper understanding of clients’ risk preferences, it should also be “fun” on some level. After all, don’t we all want to know more about ourselves? Engaged clients are more likely to respond with care and diligence, yielding more-accurate results.
  2. Your clients are confused or surprised by their results. Risk assessment reports should facilitate meaningful discussions with clients. Those discussions can be hindered if the report results don’t make sense to your clients. Most of us are very good at predicting our risk tolerance, so clients shouldn’t often be surprised or confused. If they are, you may spend more time trying to explain the results than on having a conversation that yields the deeper insights that can help you provide meaningful recommendations.
  3. Your clients’ risk profiles often change. Risk tolerance is a personal trait, similar to intelligence, extroversion, and creativity. Such traits tend to be quite stable over time in adulthood. Just as you don’t often see an extrovert suddenly becoming an introvert, it’s unlikely for a risk seeker to become a risk avoider over a short period of time. Small and incremental changes over time are likely, but large or frequent swings are signs that your risk tool may not be accurately measuring risk tolerance in the first place.
  4. Your clients’ risk preferences are either skewed or evenly distributed. Generally, risk tolerance is normally distributed, meaning you should see most clients cluster around the mean and fewer clients at the extremes. Results that are skewed toward the extremes or evenly distributed likely reflect an inaccurate tool.
  5. Your clients’ risk preferences seem to move with the market. Risk results that systematically ebb and flow with the market are likely reflecting perception of risk in the current environment rather than actual risk preferences. If your clients appear more aggressive during bull markets and more conservative in bear markets, you may introduce unnecessary portfolio churn, leading to poor performance. Stable and accurate risk assessment will keep clients (and you) focused on long-term goals.
  6. The results don’t align with your expectations. Risk assessment is not just a measurement tool. It’s an alignment tool, connecting your experience and knowledge to the results. The results should align with your intuition, giving you confidence to relay them to your clients and make appropriate recommendations.
  7. Your risk tool is not independently tested and reviewed. Look for rigorous research supporting your risk tool’s methodology, as well as independent testing and scrutiny. Regular reviews are important to ensure relevance and accuracy. Infrequent reviews may mean that the results are not reflective of the current population. On the other hand, reviews that are too frequent may mean the scale is unstable.

Those are the red flags to watch for. Overall, a solid risk assessment tool will have three core attributes:

  1. Defensibility. First, it must do what it purports to do and do it well. Does it meet regulatory requirements? How confident are you in the scientific validation of the tool? Can it stand up to scrutiny? Regulation sets a minimum bar; you want to be confident that you can defend the results of the tool.
  2. Personalization. Second, it should add value to your practice beyond satisfying compliance. In a saturated market, your risk tool needs to deliver point-of-difference business development benefits that allow you to personalize your services.
  3. Usability. Third, it should make your advice process more efficient, so you can save your time and energy to focus on what you do best: helping clients achieve their financial goals.

A good spring-clean can bring clarity and revitalization not just to your personal life but also to your practice. Walk your risk tool through the evaluation above. If it doesn’t pass these tests, perhaps it’s time to let it go.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Authors

Nicki Potts

Director of Financial Profiling & Planning

Danielle Labotka

Behavioral Scientist (Saving & Retirement)
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Danielle Labotka, Ph.D., is a behavioral scientist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. She conducts original research to understand how investor and advisor behaviors and biases affect financial decision-making.

Before joining Morningstar in 2022, Labotka was a research fellow at the University of Michigan working on projects funded by the National Science Foundation. Her work has been published in academic journals such as Cognition and Frontiers in Psychology.

Labotka holds a bachelor's degree in anthropology and comparative human development from the University of Chicago. She also holds a doctorate in psychology from the University of Michigan.

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