Risk Tolerance as a Personality Trait

As an advisor, your job is to keep clients comfortably invested for the long term. But that idea of comfort does not look the same for all investors.

Some clients love the thrill of watching their investments spike and tumble. Others cautiously guard their nest egg against any market whims.

How accurately can you predict a client’s reaction to future downturns?

Data shows that, when measured correctly, risk tolerance is a stable personality trait that can help you engage with clients.

In a recent webinar, Jason Stipp, director of product management, breaks down risk assessment for personalized investment plans. Watch on demand.

Table of Contents:

• No, risk tolerance doesn’t change with the stock market.
• Why does risk profiling matter?
• Managing client relationships by understanding risk tolerance and loss aversion.
• How risk profiles might influence retirement planning.
• What’s your client’s risk tolerance comfort?
• How to line up risk tolerance, goals, and preferences.

Risk tolerance is a person’s willingness to take risks in exchange for the long-term possibility of reward. Data shows that risk tolerance is a consistent personality trait. It doesn't change with market wins or losses.

During the volatile markets of the last 20 years, global risk tolerance scores have remained meaningfully the same. We found that when the same client is retested, they score very similarly even a decade between tests.

With a valid risk tolerance profiling system, you’re more likely to see clients stay the course during severe market downturns.

Growing need for advice

Employers have made a seismic shift from pension plans to defined contribution plans. If your client wants a dignified retirement, they hold the responsibility. Employers contribute money, but employees are on their own to decide where to invest, how much to save, and how to allocate their portfolio.

Unlike their advisors, clients don’t have professional training as financial planners. Only about 20% of households have a formal financial plan. How do investors know if they’ve put away enough for retirement? How do they know they’re managing risk well?

Today’s investors need guidance from financial advisors who understand their personal goals and risk tolerance.

Raised customer expectations

From Netflix to healthcare to financial advice, consumers expect personalized experiences. Your clients want plans that reflect their personal needs instead of off-the-shelf options.

Personalization will be important to retain business in the years to come. In one McKinsey survey, 70% of respondents ranked personalization as highly important to their banking experience.

Growing regulatory scrutiny

New know-your-client regulations require advisors to understand their clients in specific ways. Rules require advisors to document their work to recommend investments in their client’s best interest.

Enhanced rules include:

• Regulation best interest.
• The Department of Labor’s Prohibited Transaction Exemption 2020-02 governing 401(k) rollovers and client best interest.
• The SEC marketing rule, requiring advisors to show clients performance data net of fees.

Sprawling tech stacks

Often, advisories piece together software to cover the full advisor process, seeking out the best-in-class options. But not all products live up to their promises of seamless data integration.

Disparate systems can lead to workflow snags, higher costs, and uneven advisor-client experiences. Advisory firms need a consistent workflow with consistent outputs that clients understand.

Risk composure is the loss aversion people might feel when the market loses value. Nobody likes to lose money. Your clients may feel anxious, but they also know they must stomach a short-term downturn to meet their long-term goals.

Risk composure is similar to, but separate from, risk tolerance. Advisors need to be able to measure risk tolerance to build a financial plan. If advisors can only measure risk composure, they won’t have a reliable understanding of their clients.

Portfolios that fit a client’s real risk preferences can help them avoid trigger-finger decisions that go against their goals.

The Investment Planning Experience gives you an at-a-glance client overview. It’s easy to find clients who need to be profiled or retested. If the market is having a bad week, you can head off anxious calls with a reassuring email to clients with lower risk tolerance.

While risk tolerance is a stable personality trait, other factors—like the time horizon—can affect how much risk your clients can afford.

High-octane clients might feel ready to assume financial risk. But if they plan to retire in five years, their limited time horizon constrains their portfolio options. They might not have the time to weather a downturn before they plan to withdraw money from their portfolios.

When you optimize portfolios for risk, you can help keep clients comfortably invested for the long term.

On the surface, Morningstar’s risk tolerance profiling tool might look like any other questionnaire. But it’s what’s under the hood that sets it apart.

Morningstar’s risk profiler has been administered nearly two million times since 1998, including client retesting. It identifies five main groups, from very low to very high risk tolerance.

Conservative investors might associate financial risk with danger. When facing a major financial decision, most are more concerned with possible losses. It’s important to them that the value of their investments doesn’t fall.

Aggressive investors often think of financial risk as an opportunity. They usually want the value of their investments to retain purchasing power. They might want to bet on emerging investments like crypto, even if it means risking money.

Most investors fall in the middle of the road. This group will feel comfortable taking on some risk but will resist going overboard at the risk of a future market downturn.

Your clients are more than a risk tolerance score. They want to see portfolios that are made for their preferences, goals, and life circumstances, not pulled from a list of five.

With the risk comfort range, Morningstar highlights a range of potential portfolios that can cross over between groups. You have the flexibility to tailor investments to each client for the perfect fit.

Here’s how it slots into your workflow.

While Morningstar might be best known for its data and ratings, our new Know Your Client capabilities help you better understand your clients.

Here’s how you can personalize portfolios for long-term client satisfaction.

Set goals and uncover preferences

With science-backed goal surveys, you can map the path ahead together with your clients. What do they hope to accomplish with their investments: Are they saving for retirement? Planning for a child’s wedding? Dreaming of home renovations?

With a Monte Carlo analysis, you can show your clients if their goal is attainable and, if not, what contribution adjustments they would have to make. When you lead conversations about actions and trade-offs that work toward your clients’ goals, you’re demonstrating the value of your advice.

Goals-based planning helps your clients stay focused on the outcomes, not on the numbers. When clients understand why they’re investing, they can be more motivated to stick to the plan.

Analyze current portfolios

The Morningstar Portfolio Risk Score shows the risk a client is currently taking. The model assigns portfolios or proposals a numeric score from very low to very high risk tolerance, compared to portfolio benchmarks.

These benchmarks go beyond Morningstar analyst opinion. The Portfolio Risk Score uses the market’s collective wisdom to define a conservative or aggressive portfolio. Target allocation indexes track professionally managed target risk investments around the globe.

The score can start a conversation about sources of investment risk.

Measure risk tolerance

Understand your client’s appetite for risk with the risk tolerance questionnaire. The profiler will give you a risk comfort range, which covers a range of portfolio risk scores that could fit your client’s personality.

Is their current portfolio at the top of their comfort level, or above it? Do they have the capacity to take more aggressive risks to reach their goals?

The Risk Comfort Range bridges risk groups to give you more flexibility to build portfolios. From there, you can use your professional judgment to customize your proposal.

Create custom, compliant proposals

With an accurate goals and risk assessment, you have the personal information you need to customize investment proposals.

In Morningstar Advisor Workstation, advisors can assemble investments into a portfolio, adjusting the overall asset allocation and underlying holdings.

The proven risk methodology creates a solid defense and decision trail, should the suitability of a client’s portfolio ever be challenged. In the platform, you can also generate FINRA-reviewed reports that cover the required details and disclosures.