By MARK FRIEDENTHAL
As fintech use and popularity grows among advisors, an area often overlooked is risk assessment technology. When industry professionals conjure up thoughts of risk tolerance assessment tools, usually it is just a basic personality profile quiz that comes to mind. Risk assessment tools offer so much more today, and should truly be seen as a cornerstone to any part of a client’s plan. By understanding a client’s willingness and ability to actually take risk, an advisor can better service their long-term investment and financial objectives.
For advisors on the hunt to incorporate risk tolerance technology into their practice, there are a few critical components they should look for during the vetting process. Below are meaningful must-haves that blow those traditional “risk tolerance quizzes” out of the water. Advisors should ask:
Does it separately evaluate their willingness to accept risk and their ability to take risk? Both are equally important and independent dimensions of how much risk someone should be taking.
Does it incorporate cash-flows? To accurately assess someone’s ability to take risk, you need to know their spending and savings pattern, their assets in and outside their retirement plan, and their other sources of retirement income. Simply judging a simplistic personality test will not provide you their actual ability to take risk now or in the future.
Does it include dynamic inflation? While it’s generally understood that portfolio returns in the future are uncertain and can travel quite a few paths, representing dynamic paths for inflation can be just as important.
Does it estimate the reasonableness of the client’s assumptions? The single best barometer of someone’s financial security is the probability that they (or their spouse) will outlive their money. Advisors must be able to incorporate likely evolving asset allocation, dynamic inflation, and dynamic mortality in order to provide a reasonable estimate.
Is the output easy to explain to a client or prospect? Having deep, robust mathematics at the heart of your analysis is important. But, if the output can’t be explained easily or made meaningful, it may not be an effective tool.
With better technology and more robust risk tolerance analytics, advisors can offer efficient and effective investment management plans to clients, both for today and as the client’s future evolves.
Mark Friedenthal is the founder of Tolerisk, the pioneer of the 2-dimensional risk tolerance assessment tool for investment advisors.