How to talk to clients about their risk tolerance

How to talk to clients about their risk tolerance

Breaking down financial jargon in a way clients can understand

When you hear the term “risk” thrown around in conversation, your heart may skip a beat—already planning on and preparing for the next adrenaline rush your body will experience. The thrill of doing something risky, like taking Vegas head-on by doubling down on blackjack or going all-in with a bluff, is tempting for many people, but when it comes to finances, the term “risk” may not be quite as exciting—especially for your clients.

The inner workings of financial risk aren’t quite as clear as clients may think—and average savers may not understand the benefits of opening themselves up to financial risk (who wants to risk losing their hard-earned money, after all?), meaning they could potentially lose out on large returns over the course of their career.

Since there are benefits of utilizing an aggressive model portfolio in various situations, it’s vitally important that advisors know how to talk to clients about their current level of financial risk and determine what their risk level tolerance is. But study after study has proven that clients don’t understand financial jargon the way we think they do, and we need to be cognizant of that.

And one of the common topics clients don’t have quite as good of a grasp on? Risk level tolerance. Clearly, it’s imperative for advisors to break down “risk” in a way that makes sense to the client.

Here’s how to do it.

Explaining financial risk tolerance to clients

Before making any assumptions about what your client does know or doesn’t know, simply ask them if they’re familiar with the concept of risk tolerance and how comfortable they are discussing their own position on the risk tolerance scale. If they give you a confused look or admit they aren’t super knowledgeable about the topic, you know you have some explaining to do.

We recommend starting with the background and basics of risk level tolerance, then providing examples or analogies later on as necessary to help them understand.

Start by reminding your client that while the stock market is unpredictable, it has a natural tendency to ebb and flow over time. There will be periods of intense growth (bull markets) and periods of dramatic losses (bear markets)—and clients need to have a realistic understanding of how the market swings as time goes on. Remind them that stocks can be very volatile in the short term, so it’s important for them to maintain good long-term decision-making and not immediately sell, sell, sell when there’s mayhem on Wall Street. Make sure they understand that it’s often worth it to hang in there in periods of downward swings, because the average bear market lasts just 1.3 years (with an average cumulative loss of 38 percent) while the average bull market lasts an average of 6.5 years with total returns averaging a whopping 333 percent [1].

Once you’re confident that the client understands the natural flow of the stock market and won’t run for the hills the first time they see a substantial loss in their account, you can begin delving into the details of risk level tolerance—starting with the risk tolerance scale.

But before throwing around any jargon, give them an analogy or frame of reference they can use to understand the various levels of risk tolerance as you discuss it. Tell them to think about it in terms of professional football; there’s always a certain level of risk football players face when they take the field, mostly in the form of serious injuries. For a young player, the potential to make a lot of money likely far outweighs the potential risk of getting injured. The first few injuries the player sustains may be “worth it” in their eyes because the potential to keep making money is so high, but as they get older and their body can’t recover from the injuries as quickly or easily, they may become less tolerant of that risk.

The financial industry works the same way. Young investors may subject themselves to higher levels of risk through a more aggressive model portfolio to maximize their potential earnings and returns, but as they get older and closer to reaching their retirement, a bear market may have a more significant impact on their account—one they may not be able to fully recover from. Most investors are not tolerant of this risk. Instead, they want to move their focus to a more conservative approach and protect their assets by minimizing risk in the event of a market downswing.

Once clients understand this concept, it’s time to really get into the details of risk level tolerance and the risk tolerance scale. Use easy to understand language, like:

  • Conservative risk tolerance

    • Minimum risk, but minimum potential returns—little to no risk in investment portfolios

    • Best-suited for investors who are planning on withdrawing money from investments in the near future (under 5 years)

  • Moderate risk tolerance

    • Some risk to principle investments, but adopts more of a balanced approach to potential growth and loss

    • Good approach for investors with a moderate amount of time left before they plan to access the funds (5-10 years)

  • Aggressive risk tolerance

    • Maximum potential returns, but maximum risk

    • Best-suited for younger clients with plenty of time, who don’t plan on needing the money any time soon (more than 10 years)

When trying to explain the various levels of risk tolerance in a way that actually resonates with your clients, you may need to get creative. While we would normally encourage advisors to avoid using clichés to connect with clients, when it comes to confusing jargon, well-known clichés may not actually be the worst idea.

For example, you could help explain what the risk tolerance scale is with a “fund growth vs. sustain” approach. Or what it means to have an aggressive risk tolerance by using phrases like “no pain, no gain” or “having an ‘in it to win it’ mindset.”

Finally, once your client understands the background and basics of financial risk, you can begin measuring their risk level tolerance.

You might also be interested in: How to build relationships with clients as an advisor

Measuring your clients’ risk tolerance level

When assessing your clients’ risk tolerance level, you’re essentially asking them, “What’s the worst thing that could happen to your investments before you would panic and sell them off?”

Would a ten percent loss annually scare them into selling off their investments? What about a five percent loss monthly? And vice versa, what type of gains would they be willing to withstand that risk for? In their mind, would a 20 percent return over three years make up for any potential losses? What percent return annually would they deem acceptable?

If you’ve been working with your client for a good amount of time, you may already have an inkling of what their risk level tolerance is, but it’s important to truly understand where exactly on the risk tolerance scale your client falls. If you aren’t sure exactly where they’re at, start by asking these questions:

  • Are you willing to take on above-average risk to get above-average potential returns? (determines risk comfort)

  • How anxious do you feel about the potential to lose money in the stock market?

  • Would you be tempted to sell your investments if they lost money over the course of one year?

  • How many more years do you plan on working before you retire? (determines time horizon)

Once you have the answers to these questions, you should be able to place them on the risk tolerance scale and talk about what type of fund portfolio would be most appropriate for them. Remind them that as they get older, they’ll want to re-evaluate their level of comfort and adjust their fund portfolio as necessary to reach their overarching retirement goals.

Taking the time to help clients truly understand jargon and complex financial topics certainly takes time and effort, but doing so will go a long way in showing clients you really care about their financial future and retirement outcomes. And once your clients understand what a valuable tool you can be in helping them reach their long-term financial goals, you’ll enjoy a stronger relationship and higher level of trust—ultimately leading to higher client retention and additional referral opportunities.

If you need any help along the way, we’re here to support you. Check out our financial advisor resources and dedicated advisor site, or contact us today!


[1] History of U.S. Bear & Bull Markets, First Trust, 2018.