risk

Six Phrases Never To Use When Talking About Risk

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Q4 hedge fund letters, conference, scoops etc

risk

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Whenever I start with a new advisor as a client, we go through an exercise that helps me learn about their business. I ask the question, “What is the most disappointing reason you ever lost a client” or “What is an example of a time when you didn’t click with a client,” here’s what I get as the response:

  • I lost a client I really liked because the market went down and he/she felt uncomfortable with how much they lost.
  • We’re in the process of losing a client because he/she always takes credit for the good stock picks in the portfolio yet we get credit for the stocks that don’t do well, even if it’s only a short term decline.
  • They left me for another advisor who promised them better performance.
  • They had unrealistic expectations about what level of return they should achieve given how much risk they were able to take.

A perilous road for both advisor and client

I have personally experienced this problem myself. When I was an advisor, I had one client who had moderate risk tolerance. After years of telling me she was happy with the performance, one day she dropped a line on me that went something like this:

(In an edgy tone of voice). “Lately it seems like I’m losing more money than I’m comfortable with. I want that to be fixed right away.”

Fix it? Like I can wave a magic wand. I didn’t know what to say. I felt betrayed. To make it worse, this client was an attorney and I had the fear I was going to get sued.

And that’s the whole problem. We’re both afraid for our life savings; she doesn’t want to lose hers in the market, and I don’t want to lose mine getting sued by her.

The communication between two people defines the relationship. There’s a major misalignment of expectations between the client and advisor when it comes to risk, and it’s not the client’s job to solve the problem.

The whole risk conversation has to change.

Six phrases to avoid using when talking about risk

1. “This model portfolio averages 15% return year-over-year.”

They hear: I’m going to make 15% this year.

When this becomes problematic: Remember that it is statistically a rarity for the market to achieve its average – Aaron Klein of Riskalyze and I discussed this on a podcast that you can listen to here. Inevitably you’re setting your client up for disappointment.

2. “According to this risk questionnaire, you’re a conservative investor.”

They hear: I won’t lose any money.

When this becomes problematic: The problem with putting people into categories based upon what a risk questionnaire says is that the output isn’t clearly defined.

It’s not like taking a blood test where I know I need medicine if my blood sugar is too high. The typical terms that advisors use, such as “conservative,” “moderate” or “aggressive” can be interpreted to mean so many different things.

It’s like saying, “Based upon this style assessment, your best color to wear is blue.”

Okay, great! I like blue!

But what does that mean? Navy blue? Baby blue? Teal blue?

Moreover, risk questionnaires tend to be based on all kinds of fallacious ideas such as the younger you are, the higher your ability to take risk. Do you know how hard it is to score as a conservative investor on one of these questionnaires if you’re young?

Or that women are more risk averse than men. Who said this by the way? Is there any real evidence supporting this? It’s a myth that everyone believes for no reason, just like Santa Claus.

Read the full article here by Sara Grillo, Advisor Perspectives


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