How To Identify Client Risk

How to identify client risk

The prospect of obtaining a new client is exciting and so it should be. However, there may be some clients that could compromise your business. So how can you tell who they are and what you should do?

A good place to start is by analysing the risk tolerance of your client. A major reason we need to consider the risk tolerance of our clients is the difficulty in communicating our understanding about risk, and their interpretation of it.

Studies in the field of behavioural finance (Katz, 1998; Elsayed & Martin, 1998) reveal that clients’ goals and objectives are often poorly developed and unrealistic. The initial meetings with advisers can be quite difficult for some clients because of the lack of understanding that they might have about their “financial selves”, and the investment risks that they might be willing to accept.

We know that people become anxious and stressed in dealing with issues that are important to them. They become anxious if they perceive these matters to be under threat or to be less under their personal control.

In managing their personal financial affairs, people are attempting to achieve a level of financial independence that allows them to meet not only their basic human needs, but also higher-level needs for self-development and self-improvement. Making the best decisions about financial affairs can challenge their sense of being in control.

In the 12 years I have been involved in delivering the PIAA, PIA01 Property Investment Advice Course, student’s definitions of risk have been inconsistent. However, the one definition that we have all settled on is “Opportunity vs Uncertainty”. This definition has allowed us to assess risk from a financial advice perspective.

The ‘opportunity’ for many clients is their goals and ‘uncertainty’ can be described by the client’s current situation. What is the client able to do in their current situation to successfully achieve their goals?

For mortgage brokers a ‘fact find’ can be quite revealing regarding the client’s attitude to risk and interpreted as the client’s ability to manage their funds over time. We could call this the client ‘Risk Profile’. It can be categorised as low, medium and high.

Look through a few ‘fact find’ documents and it will become clear how to categorised the Risk Profile of a client. Clients with a high-risk profile may be problematic and may need further education in budgeting or financial management prior to becoming a client.

Financial risk tolerance involves perceptions about how confident people are in their ability to make good financial decisions, their views about borrowing money, and how much of a risk in terms of financial loss they believe they could accept in achieving financial gains in the longer term. Because of the complexity of the concept of risk tolerance, its measurement is also viewed as not an exact science (Lamm-Tennant, 1994).

Through gaining an accurate assessment of a client’s risk profile, an adviser can develop a tailored financial plan that better reflects the client’s perception of the acceptable trade-off between risk and the compensation required for bearing risk.