A Cat On A Hot Stove

What is the duty for an advisor in respect to a client’s risk profile?

There is quite a lot of material surrounding the question of identifying the risk tolerance and capacity and exposure but not much on what you should do about it once you find it.  Appropriate investments and place it in the file for the compliance folks I suppose. 

What if the risk profile is a naive one?

Risk is puzzling and it is especially so when people have “Uninformed or misinformed risk aversion.”  The condition whereby someone “knows” that stocks are too risky and provincial bonds are too risky compared to federal bonds.  In simple terms they have a strong aversion that is not connected to realistic external factors.

Naive risk tolerance is a problem too.

Uninformed is different from misinformed.  My son Peter reposted a blog by Teacher Tom in Seattle.  The Process of Risk.  Some early childhood education points may translate.

There are some useful thoughts:

  1. “It’s not the degree of risk that’s important to education, but rather, it’s the process that matters.”
  2. “I perceive no danger in him being less than a foot in the air, but that’s unimportant because he does.  Perhaps, tomorrow they will climb higher, but for today, they have found their “just right” level of risk”
  3. “It’s when we compel or help children into situations not of their own making that we most often place them in the greatest danger.”
  4. “A better way to support our children as they explore their physical capabilities, as they challenge themselves, is to move a little closer and wait for them to request assistance. And even then, my response is often along the lines of, “I won’t help you, but I won’t let you get hurt.”

Yield is an important part of growth and risk an important part of yield.  In building wealth, yield is the equal of time and much more important than how much capital you may have to invest.  Minor yield variations provide considerable flexibility.

I do not suppose that a child learning to climb a tree is the same as feeling comfortable with retirement assets in the stock market, but I think Teacher Tom has some ideas that can help with insight into what an advisor can do about a risk averse person.

Be aware that the total of a person’s risk tolerance and experience tends to remain constant throughout life.  Bullet-proof teenagers have no experience so lots of risk tolerance. Older people have lots of experience but little tolerance.  Ask how a client came to their fear.

No experience is easier to deal with.  Educate and support.

Adverse previous experience is more difficult.  It teaches, but often without enough context.  Mark Twain pointed out that a cat that jumps on a hot stove won’t do it again, but he won’t jump on a cold stove either.  It is hard to reshape the context.

Knowing too little and learning the wrong lesson both prevent readily available success.

Contact: don@moneyfyi.com  

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

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