Managing Your Clients’ Risk Perception

Kol Chu Birke, CFP®
Kol Chu Birke, CFP®

07.16.19 in Wealth Planning & Investing

Estimated Reading Time: 8 Minutes (1583 words)


While we often focus on “risk tolerance,” when the markets head up or down precipitously, managing your clients’ risk perception is actually the key. Of course, to do so, we must first understand the difference between risk tolerance and risk perception. In a nutshell, the reason why people’s risk tolerance can change drastically during times of market volatility has to do with this notion called risk perception. Research from the CFA Institute shows that risk tolerance is a fairly stable “personality trait”—which stays the same unless someone has a life-changing experience. Risk perception, on the other hand, is an emotional, temporary judgment of the severity of a risk during a certain time frame.

A heightened perception of risk can come and go fairly quickly. But when it’s in play, your clients’ short-term decision-making—how well they maintain an even keel during market swings—is what matters. So, in addition to considering your clients’ fundamental risk capacity and tolerance, coach them on how to keep their composure when the markets are doing particularly well or poorly. These techniques will allow you to keep more focus on financial planning, and less on managing tricky client behavior. 

Risk Tolerance Vs. Risk Perception

To illustrate the difference between risk tolerance and risk perception, let’s consider a driving analogy. 

Imagine you’re driving down a winding road you know fairly well. You’d like to listen to music you recently downloaded, so you look down to grab your phone from the console. By the time you look up, you realize the road has curved left, and you’re about to run right off it! Fortunately, you react in time and swerve back into your lane. For the next 10 minutes, regardless of whether you’re typically a careful or aggressive driver, you drive as carefully as possible because your mind is very conscious of (if not overestimating) the risk. Of course, you’re the same person you were 10 minutes ago (and have the same risk tolerance). But due to almost running off the road, your awareness of danger (your risk perception) has skyrocketed.

Your typical driving style is guided by your automotive risk tolerance, while your risk perception is guided by this potentially deadly near miss. So, while interrelated, risk tolerance and risk perception are fundamentally different things. Of course, one’s objectives and tolerance for risk should drive one’s investment strategy. But risk perception is the element that can cause clients to push for a more aggressive portfolio when the market is at a high point, and for moving to cash when the market is moving down. 

Talking to Clients About Risk Perception

Use a relatable analogy. Given current worries about the economy and markets, now is a good time to introduce or reinforce the notion of risk perception. Share the driving analogy with your clients. It’s an effective way to let them know that although risk perception is emotionally real, it causes us to downplay or inflate the dangers we face. By educating clients about risk perception, we can help them avoid poor decision-making and self-destructive financial behavior.

Ask clients if they’ve experienced swings in their perception about the risks of investments and, if so, what action they took. If clients express any regrets, ask what they would like to do in the future and how they’d like you to help them stick to that choice. For some clients, a talk like this is enough to manage their perceptions and encourage greater risk composure going forward.

Share distraction strategies. You can also ask clients what strategies they have used to help them get through moments of panic in the past. If they don’t have ideas, suggest something like: 

  • Go on a news diet by tuning out the websites, TV channels, and radio stations that induce panic.

  • Dive into a hobby (especially one that gets them moving physically, into nature, giving back, or into a social setting, as these hobbies are highly correlated with causing sustainable positive emotions).

  • Have clients ask you to rerun projections for their financial plan based on market actions to pressure test the drops.

These strategies apply to good times as well as bad. It’s important to keep in mind that when the market is too good for too long, risk perception can decrease to an unrealistic level (just as we can get too relaxed when driving on a long stretch of empty highway). During strong markets, clients might want to move into a more aggressive investment allocation than their risk profile warrants. So, remember to encourage clients to maintain their composure in good times as well as bad.

Managing Times of Crisis

Once you've taken steps to educate your clients about risk, it’s time to start preparing for the inevitable crisis. First, compile a list of clients who will likely need extra support in the event of a dramatic pullback in the market. Second, put together a few letters (approved by your firm’s Compliance department) that generally address the most likely scenarios. At the first sign of trouble, you’ll be able to quickly send an email to your most reactive clients—assuring them that you know what’s going on and you’re watching over their portfolio. Let them know you’d be delighted to schedule some time to talk about any concerns they may have.

What about the folks who call in a panic? When it’s necessary to have these difficult conversations, three powerful levers are at your disposal:

1) Apply empathy. Clients want to know you’ve heard them and that their feelings are normal. Even if clients sound frustrated or angry, these feelings might be what psychologists define as “secondary” emotions. Their core feelings, known as “primary” emotions, may be fear, sadness, or joy. To support these deeper feelings, it’s important to use empathy. But you also need a strategy to get clients to pivot from secondary to primary emotions.

Asking your clients questions often helps move them from an emotional to a rational state, where they’re better able to listen. Here’s a sample discussion:

  • Ask an empathetic question: “It sounds like you’re frustrated about not having enough money for retirement. Is that at the core of what you’d like to find out?”

  • Listen to the client’s response, then say: “That makes sense. This type of market is hard for many clients to weather. In addition to rerunning your financial plan to see your current projections, what else do you think we should consider doing?” (If this provokes a client to suggest an inappropriate action, you’ll have the opportunity to handle the problem rather than never hearing about it.)

  • Ask if clients would like your help riding out their emotions: “Even with this drop of 28 percent, you’re still on track to meet your goals. I know it can be hard to sit by and watch a portfolio go down, but many of my clients find certain techniques helpful—would you like some ideas? If they say yes, share that you find it helpful to come up with a short list of things they would enjoy doing, in order to not focus on the market. If you know of any of their hobbies, even better. You can say, “You’ve mentioned you enjoy cooking and tennis in the past—do you still enjoy these activities or do others come to mind?”

2) Leverage your own confidence. To project your confidence as a steadfast coach and business partner, you might say:

  • “Whether due to the market, illness, or any other hardship in life, I have stood side by side with my clients for 16 years and counting, and I’m not going anywhere. I know the current situation feels frustrating and nerve-racking, but just know that I’m here with you in this. And I’ve seen you work through some tough stuff. I know that you’re smart and will continue doing the prudent things that have served your family well.”

3) Focus on your goal. In any difficult conversation, I like to imagine that my goal is my lifeboat. The further I get away from that goal, the more likely I am to drown (credit: Brad Phillips, In some conversations, your goal will be to preserve the relationship, even if that means giving a bit on the asset allocation. In other conversations, your goal will be to hold the line to protect clients’ futures (and your integrity), even if it ultimately means losing that client.

So, before or during any tough conversation, figure out your goal. If you find yourself adrift, acknowledge this but emphasize what’s important:

  • “I apologize for letting us get off track. You called with concerns about your portfolio, and my goal here is to make sure that we make the right decision—one you won’t regret. Let’s talk about the pros and cons of each of our options.”

Remembering Self-Care

When dealing with emotional situations, it’s easy to let ourselves be overcome by “compassion fatigue.” This condition can occur when we spend so much time and energy empathizing with others that we ourselves feel overwhelmed. Compassion fatigue is well-known in medical and therapy professions, but it’s also common in the advisory field. So, make sure you have a plan to nourish yourself, perhaps by turning to your favorite activities for self-care just as you suggest that clients do in times of stress. By preparing your clients—and yourself—for market ups and downs, you’ll be well equipped to manage clients the next time their risk perception skyrockets, whatever their risk tolerance.

Editor’s Note: This post was originally published in October 2017, but we’ve updated it to bring you more relevant and timely information.

This material is for educational purposes only and is not intended to provide specific advice.

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