Financial Advisors

Accelerating Innovation in Risk Measurement Tools For Financial Advisors

Risk is not an absolute. It is ever changing with many shifting variables. That is why risk is so hard to succinctly and accurately verbalize with most investors not knowing how to express their very personal feelings about risk or even wanting to discuss their changing perceptions of it. Rapid advancements in technology and data analytics are helping to create new solutions on how to approach risk measurement with clients.

It is for this reason the Institute for Innovation Development sought out Institute member Larry Shumbres, CEO of Totum Riska FinTech company that provides a unique risk tolerance tool that is constantly adding new technology and approaches to the client risk measurement quandary for advisors. He shares with us what he sees as transformational strategies for more holistic risk management measurement and the risks of not adapting them.

Hortz: What do you see as the biggest risks in risk management for advisors in today’s environment?

Shumbres: My concern is that, especially as economic and market risks seems to be climbing, many advisors are not accurately assessing their client’s risk profile. Inaccurate, confusing and outdated investment risk assessments pose a major business risk for them.  Most risk assessment tools are based on a client’s feelings about risk, not how much risk they can take given their current life situation.

It’s important to use a risk tolerance tool that calculates risk capacity which also has a metric, in addition to risk preferences. Then you can compare the scores in order to accurately assess the right amount of risk for your client’s current stage in life.  Advisors also need to be wary of risk tolerance tools that do not utilize in-depth algorithms to incorporate more client data to calculate the risk score.  Using the wrong product could be a costly mistake that can potentially lead to arbitration.        

Additionally, most advisors give the questionnaire only once. If you use risk measurement questionnaires, they need to be given at least annually. Assessing your client’s multidimensional risk profile on an ongoing basis helps advisors better guide them to reach their goals, even through a bear market.

Not only does this better frame the investment strategy, it’s also a great way for advisors to reinforce their client relationships.  In an era when people deviate from their parent’s financial advisor in favor of robo-advisors and their own personal networks, any opportunity to connect with clients is a plus. 

Hortz: What do you recommend are important questions that advisors need to ask about their risk measurement process at this junction in the market?

Shumbres:  I highly recommend that advisors take a fresh look at their risk tolerance tool. Does it calculate risk preference, risk capacity, or both? Does it cover the new SEC BI rule?  Is it truly a risk tool or a prospecting tool?  Has their risk questionnaire been tested during a market cycle or was it copied into a bull market?  Is the questionnaire easy to take? When was the last time their clients took the questionnaire? Will it protect them in arbitration?

Hortz: Based on your research, what have you been uncovering that is important to note in regards to client risk measurement issues today?

Shumbres: In our latest research we found 65% of investors are taking a risk tolerance questionnaire via their mobile phone, so it is important that the risk tool be mobile friendly. We also found from talking to clients that most risk questionnaires are difficult for them to understand, so investors are guessing at the answer which negates the accuracy of the score.  Academic research claims that a person or household has one major life event annually that will impact their investment objective.  Question then becomes: Is your client risk measurement  process and risk tool you are using capturing those life events on a regular basis? 

Hortz: Why do you feel so strongly about changing client risk measurement into a more data driven approach versus just client questionnaires?What do you see as the future of this area?

Shumbres: There is a lot of data out there on everyone, even if they’re not an internet user.  Think about it. If you have a bank account, mortgage, loan, credit card, or iPhone - all of these products are collecting data. Totum Risk now gathers this data through population analytics which provides enough information to assess someone’s risk tolerance without them having to take a long questionnaire.

Can you imagine an advisor receiving an alert that a client’s risk score has changed and why?  How about already having the framework of a prospect’s risk tolerance before you even meet with them?   With a data driven approach, I know an advisor can have up-to-date information that will help them invest their client’s money with a stronger more precise client risk measurement. 

Hortz: How exactly are you further evolving your risk measurement tool?

Shumbres: Instead of asking more questions, we determined and incorporated over 100 variables based on a person’s life events that would impact the risk capacity score by more than 5%.  As we pull in data, if one of the data points triggers a variable, then the advisor will be alerted of the life event and the risk capacity score will be updated.  As we continue to gather this data, we will be able to show the advisor risk trends and be able to share with them how a client’s risk scores compare to a peer with the same income, zip code, or sector they work in.  This adds a tremendous amount of value and backup for advisor compliance around Know Your Customer and suitability issues. 

Hortz: What best advice do you have for advisors about the key decisions they may need to make about client risk tolerance measurement and management?

Shumbres: Many advisors believe that they already know their clients well and do not need risk tools or they are already using a risk questionnaire, but haven’t re-evaluated how risk scores are actually calculated, and the accuracy and value they bring to their client relationships. With a growing market risk environment and the increased use of big data and digital technology, it is going to become hard to defend against the inevitable wave of lawsuits that will likely come from clients or their heirs if a limited risk management process or an inaccurate risk tool was used as part of their investment strategy...especially because the SEC now requires it. 

The most strategic way for advisors to protect their business, reputation, and client portfolios is to assess their current risk tolerance tool. Focus on facts over feelings (risk capacity over just risk preference), multi-scoring over a one dimensional approach, ease and accuracy of gathering information, and how the scores are calculated. It’s imperative for advisors to also have a plan on how to monitor changes in client life events that will affect their investment strategy.

The Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We position our members with the necessary ongoing innovation resources and best practices to drive and facilitate their next-generation growth, differentiation and unique community engagement strategies.The institute was launched with the support and foresight of our founding sponsors - Pershing, Voya Financial, Ultimus Fund Solutions, Fidelity, and Charter Financial Publishing (publisher of Financial Advisor and Private Wealth magazines). For more information click here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Bill Hortz

Bill Hortz is an independent business consultant and Founder/Dean of the Institute for Innovation Development- a financial services business innovation platform and network. With over 30 years of experience in the financial services industry including expertise in sales/marketing/branding of asset management firms, as well as, creatively restructuring and developing internal/external sales and strategic account departments for 5 major financial firms, including OppenheimerFunds, Neuberger&Berman and Templeton Funds Distributors. His wide ranging experiences have led Bill to a strong belief, passion and advocation for strategic thinking, innovation creation and strategic account management as the nexus of business skills needed to address a business environment challenged by an accelerating rate of change.

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