Strategies for Advising Clients with Inconsistent Risk Preferences
In this article:
- What does it mean to have inconsistent risk preferences?
- How to identify clients with inconsistent risk preferences
- Strategies for advising clients with inconsistent risk preferences
Before advising a client, it is imperative to know that they have a coherent understanding of risk vs. reward decision-making.
Capital Preferences’ Decision Consistency check confirms this so you can have confidence your clients won’t make irrational investment decisions that hurt their long-term wealth potential or cause compliance issues for your firm.
What does it mean to have inconsistent risk preferences?
In the Risk Activity, clients make a series of risk vs. reward tradeoff decisions with varying levels of investment opportunity.
A client with consistent risk preferences takes a higher amount of risk in the scenarios where the opportunity presented to them is higher, while taking less risk in the scenarios where the investment opportunity presented to them is lower.
Alternatively, a client with inconsistent risk preferences makes decisions in the Risk Activity that contradict each other, taking high amounts of risk in low opportunity scenarios and low amounts of risk in high opportunity scenarios.
How to identify clients with inconsistent risk preferences
If a client has inconsistent risk preferences, you will see the following notification in red that reads DECISION CHECK on their profile page:
Strategies for advising clients with inconsistent risk preferences
As an adviser, it is important to identify these clients early in the advice process and intervene as you see best. We recommend additional coaching and support throughout the advice process.
Recommended talking points:
- What were you thinking about as you went through the Risk Activity?
- Have you ever taken risks with your money before? If so, when?
- How would you explain investment risk and reward to a friend?
Recommended Strategies:
- Help them understand the trade-off between risk and reward.
- Request that they retake the Risk Activity with the additional context in mind.
- When deciding on a financial plan, emphasize why it is worth staying the course and avoid making impulsive buy or sell decisions, which can hurt their long-term wealth potential.
- Record the client's decisions in the Risk Activity internally for compliance purposes.
Having inconsistent decisions has been shown to have a negative impact on net worth at retirement when compared to those with the same lifetime income. This could be due to changing goals causing long-term strategies to never come to fruition.
Inconsistent decision patterns occur across all Attitude to Risk and Sensitivity to Loss combinations and income groups, meaning the only way to identify clients with inconsistent decision-making is to risk-profile them and see how they make decisions in the risk activity.
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If not, please feel free to reach out to us at customer-support@capitalpreferences.com