All financial advisors collect Know Your Client (KYC) information about their clients. Not only is it a regulatory requirement, it’s good business. It helps you build a winning investment approach by requiring you to collect your clients vitals.
History Of Risk Questionnaires
Unfortunately, as KYC requirements expanded in the 90’s and 2000’s advisors increasingly had to use ineffective, boilerplate risk questionnaires to meet regulatory requirements. A robust and widely available approach did not exist. This gave risk questionnaires a bad reputation. Advisors did not want to use a tool that was ineffective just to please the regulators but they had no choice. It was that, or go out of business.
Due to the forced regulatory antecedents of risk questionnaires some advisors chose to avoid as much as possible. But times have changed and we now have comprehensive risk profile questionnaires that are effective, compliant and measure more than risk tolerance (they can measure risk capacity, and goals). Below I explain why you should use a risk profile questionnaire. However, it wouldn’t be fair to talk about “why you should” without looking at the opposite, “why you shouldn’t”.
Why You Should Use A Risk Questionnaire
1. To Better Understand Your Prospects And Clients, So You Can Recommend Great Investments
There has been an explosion in psychological and economic research about decision making since the late 90’s, culminating in Daniel Kahneman winning the 2002 Nobel Prize In Economics. This research and others has taught us how people make decisions.
We’ve learnt that people suffer losses more than they enjoy gains or that people have a tendency to follow the crowd and chase returns. This was not widely documented 10 years ago. We can use this information to design a questionnaire that taps into what clients want, need and how they will react during a market correction. This data will help you build a winning investment approach for your clients.
Additionally, one study found that advisors who use traditional conversational interviews to assess risk tolerance are only 40% accurate. 60% of the time, advisors are wrong about their clients’ risk tolerance. As Michael Kitces, the well-known financial planning blogger stated “a well-designed RTQ [risk tolerance questionnaire] is actually far more effective than an advisor’s professional (but highly subjective and potentially-business-model-biased) judgment“.
2. Company Efficiency
Having a standardized process for prospecting, on-boarding new clients and completing annual reviews will save you and your company mountains of time. If your firm uses a paper based questionnaire then going online will make your life incredibly easier.
I was recently speaking to a Pocket Risk customer who said switching to a comprehensive online risk questionnaire saves her company at least a few thousand dollars a year in employee time, filling and mailing costs.
3. Risk Profiling Compliance
The compliance burden for advisors is only going one way. Up! Regulatory agencies in Canada and the UK have become increasingly prescriptive about the need to assess a client’s risk tolerance, risk capacity and goals. The US, Australia and India are not far behind. Furthermore, especially in the U.S., regulators have been increasingly fining firms and expelling individuals for suitability failures. Last year there were $18,300,000 in fines. With the new Department of Labor Fiduciary Rule, more are likely to come for those who fail to accurately assess their clients’ risk profile.
Why You Should Not Use A Risk Questionnaire
Since I considered the argument for using a risk questionnaire, lets consider the reverse. The most common reason for not using a risk questionnaire is fear of documentation.
If you are afraid of documenting your clients’ wishes then it must be because you’re worried facts might be misconstrued and used to file a complaint against your firm. That is a legitimate concern and a valid reason for not using a risk questionnaire. However, we believe the solution to this problem is not to leave a vacuum of information but to…
- Only work with clients who demonstrate integrity. Avoid litigious individuals. No matter the facts, certain types of people will always sue you if something goes wrong.
- Use documentation to protect you by ensuring there are no “grey areas” to be misconstrued. Get your clients to sign off on your decisions. A vacuum of information leaves more open to debate.
- Use tools and services that comply with the letter of the regulations and their spirit.
If a risk questionnaire is effective and compliant then all advisors should use them. Evidence shows that the conversational interviews to assess risk are wrong 60% of the time. So if you want to recommend the best possible investment approach for your prospects and clients, it makes sense to use a comprehensive risk profile questionnaire.