You will be able to tell apart how much risk a client wants to take and how much they can afford to take.
Before your next risk conversation, take the most recent questionnaire result you have for a client. Next to it, write down when that client needs the money, what else they own, what they owe and who depends on them. If the result and those facts seem to point different ways, look at the profile again. Risk profiling often mixes up two separate things, and you should keep them apart.
Risk attitude is how the client feels about losses. It covers how much ups and downs bother them and how they would react if an investment fell. It comes from temperament and experience. Some people sleep fine through a market fall, while others check their app every hour and sell at the bottom.
Capacity for loss is how much loss the client's finances can actually absorb. It depends on the information you collected in Lesson 3.3, Finances, existing cover and CPF. That means how soon the client needs the money, what share of their wealth it is, what else they can fall back on, whether they have debts to service, and whether people rely on them.
Attitude and capacity can point in opposite directions. Take a young professional with a secure income, no dependants and a twenty-year horizon. They may have a cautious attitude but plenty of capacity.
Siew Lan is a client of an adviser called Wei Ling, and her profile is the opposite of the young professional's. She is 58 and plans to stop working in four years. Her risk questionnaire came out as "aggressive". She told Wei Ling she has watched friends make money in the market and doesn't want to be left out. Later in the same meeting she said most of her savings are set aside for retirement and she still has a small mortgage. Her attitude is adventurous, but her capacity is very limited because she needs the money soon and has little else to fall back on. The questionnaire captured how she feels about risk. It could not show what her finances would survive, because a risk questionnaire records feelings and doesn't measure finances.
Your firm will have a risk profiling questionnaire. Use it every time, as the firm requires. It gives you a consistent starting point and a record of the conversation.
Treat the result as where you start, and expect to adjust it. Questionnaires ask hypothetical questions, and people tend to answer those optimistically. A client may say they would hold on through a fall of 20 percent (an example figure) and never have seen that happen to their own money.
After the questionnaire, ask about the past. Find out whether the client has had an investment fall in value and what they did about it. Ask whether they checked or changed their investments when markets dropped sharply in a past year, and how they felt at the time. A client who sold everything in a past fall has told you more than any questionnaire answer can. A client who has never invested has told you that their answers are untested, so note that in the file as well.
Wei Ling asked Siew Lan what she did when her CPF investment scheme holdings fell some years ago. Siew Lan said she sold them, moved the money back into her CPF accounts, and "couldn't sleep" while they were falling. This doesn't fit with her "aggressive" result.
When you talk about losses, use specific dollar amounts. Clients find percentages abstract but understand amounts taken from their own savings. For example, you could ask: "If you invested S$100,000 and a year later it was worth S$75,000, what would you do?" That describes a 25 percent fall in figures the client can relate to. Use the client's own figures where you can, and tell them the amount is an example.
Assess capacity for loss separately, using what you gathered in Lesson 3.3. Where attitude and capacity disagree, the lower of the two usually sets the limit. If the client is happy to take risk but can't afford to lose the money, capacity sets the limit. If the client could afford the loss but would be distressed and likely to sell at the worst time, attitude sets it.
Whichever limit applies, explain it to the client in plain words. Wei Ling told Siew Lan that her answers show she is comfortable with ups and downs, and that Wei Ling believes her. She then explained that the money has to fund Siew Lan's retirement in four years, with little else behind it. If it fell by a quarter just before she stopped work, there would be no time for it to recover. For that reason Wei Ling would suggest less risk than the questionnaire showed, and she told Siew Lan why.
Some firms require a formal override or adjustment of the questionnaire result when the adviser recommends a different risk level. Follow your firm's procedure and make sure the reason is written down.
Siew Lan might say she understands and still wants an aggressive fund for a large part of her savings. If a client still wants more risk after your explanation, you need to record it. Write down:
what the client wanted what you told them about the risks why you thought it was unsuitable what the client decided
Record the client's reasons in their own words and your warning in yours. Write the record during or straight after the meeting, while you still remember the conversation clearly. Lesson 4.4, When the client wants something you did not recommend, covers what happens after this, including any extra process your firm may require.
Most risk mistakes start in the gap between how clients answer a questionnaire and how they behave with real money. The best protection is a short set of follow-up questions about real past behaviour and real amounts, asked in every risk conversation. In the activity below you write those questions, ready for your next risk conversation.
After a risk questionnaire, write the follow-up questions you will ask to check whether the result matches how the client actually behaves with money.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).