Ability meet Willingness - Thoughts about Risk

Ability meet Willingness - Thoughts about Risk

October 30, 2018

When we construct or review a portfolio with a client, one of the critical inputs is correctly identifying his/her risk tolerance. Risk tolerance is comprised of two things: ability to take risk and the willingness to take risk. Ability and willingness are mutually exclusive but should be considered as a “couple” for planning purposes. That’s why we like to introduce both during any discussion of risk tolerance.

As part of our on-boarding process for new clients, we require them to go through a comprehensive financial plan. One of the benefits is that we discover the ability for a client to take on risk to achieve their long and short-term goals. If a client has a large amount of investable assets (and low debt), or very high levels of guaranteed income, they may have the ability to take on more risk than their financial plan requires to meet their goals. However, just because a client has the ability to take on more risk does not mean they have the willingness to take on that extra level of risk.

While the plan provides a good indication of a client’s ability to take on risk it does not provide a good indication of a client’s willingness to take risk. A good advisor will take the necessary time and steps to help determine the willingness of a client to take risk. That may consist of a risk tolerance questionnaire, an interview of the clients and their past behaviors, or both. We believe that willingness is a moving target and should be continuously assessed and adjusted if needed.

My 25 years in the business has shown me that clients often like to increase their willingness to take risk during a bull market with relatively low volatility. In an environment where stocks go up, and rarely go down, it is easy to feel comfortable taking more risk because we forget how market volatility feels. The time to assess one’s willingness to take risk is during a market correction. If your account drops by 5-10% in a month how does that make you feel? Are you ok with the drop because you’re in it for the long term? Do you view now as a buying opportunity? Are you asking your advisor if it is a good time to add to your stock exposure? If so, then you may have the willingness and ability to take more risk than is required to meet the long-term goals of your plan.

#Planning #RiskTolerance