Managing Your Clients’ Risk Perception

When the market heads up or down precipitously, managing your clients’ risk perception is key. But to do so, you must first understand the difference between risk tolerance and risk perception.

In a nutshell, the reason why people’s risk tolerance can be drastically different from their reactions in times of fear or greed has to do with this notion called risk perception. Research shows that risk tolerance is a fairly stable “personality trait”—something that stays the same about people unless they have a life-changing experience. Risk perception, on the other hand, is an emotional state, which can come and go fairly quickly.

To illustrate the difference between risk tolerance and risk perception, let’s use a driving analogy. 

Imagine you’re driving down a winding road you know fairly well. You’d like to listen to music you recently downloaded, so you look down to grab your phone from the console. By the time you look up, you realize the road has curved left, and you’re about to run right off it! Fortunately, you react in time and swerve back into your lane. For the next 10 minutes, you drive as carefully as possible because your mind is overestimating the risk. Of course, you’re the same person you were 10 minutes ago (your risk tolerance). But in the face of almost running off the road, the awareness you have of the danger (your risk perception) has skyrocketed.

So, while interrelated, risk tolerance and risk perception are fundamentally different things and are best handled differently. In my view, one’s objectives, capacity, and tolerance for risk should drive one’s investment strategy. But risk perception is best managed through client education, along with occasional crisis management.

Reintroduce the concept. Given the length of the current bull market, now is the perfect time to introduce or reinforce the notion of risk perception. With my clients, for example, I share the car analogy. It’s an effective way to let them know that risk perception—while real in the emotions it produces—causes us to inflate the true danger we’re facing and can provoke poor decision-making.

I ask clients if they’ve experienced this kind of thing in their investing lives and what action they took. If they show signs of regretting a previous action, I ask them what they’d want to do in the future and how they’d like me to help them stick to that choice. For some clients, this is enough.

Share strategies. For other clients, I ask what strategies they’ll use in those moments of panic. If they don’t have productive ideas, I might suggest the following: 

• Go on a news diet by tuning out the radio stations, TV channels, and websites that cause panic for them.
• Dive deeper into a hobby.
• Call me to rerun a financial plan to see how the market action has changed their projections.

Too much versus too little. It’s important to keep in mind that when the market is too good for too long, risk perception can fall below a productive level. This can cause clients to want to move into a more aggressive allocation than their true needs or risk tolerance would suggest is warranted. This tendency can be part of the same education.

Let’s revisit the car analogy: When we’re on a long, quiet stretch of highway that we drive frequently, we relax. In those moments, we underestimate the risk and may speed, read a text, or otherwise put ourselves in more danger than we normally would. In bull markets, we tend to do the same thing. We see everyone else making more money, and we get less fearful and have an impulse to push our allocation toward more risky assets.

Once you've taken steps to educate your clients, it’s time to start preparing for the inevitable crisis. First, compile a list of clients who will likely need extra support in the event of a dramatic pullback in the market. Second, put together a few letters (approved by your firm’s Compliance department) addressing the most likely scenarios. At the first sign of trouble, you can send a quick e-mail to the most reactive clients—assuring them that you know what’s going on, you’re watching over their portfolios, and you’d be delighted to schedule some time with them if needed.

But what can you do for the folks who call in a panic? When it comes to these really hard conversations, you have three powerful levers at your disposal: empathy, action, and confidence.

Empathy. Clients want to know that you’ve heard them and that their feelings are normal. Further, psychologists define certain emotions as “primary,” in that they’re the core feeling. These include things like fear, sadness, and joy. They define “secondary” emotions as reactions to the primary emotions and feelings that are easier to feel, including shame and anger. So, while a client may call frustrated or angry, there is typically another underlying emotion—they likely feel sad about a perceived loss or fearful of a future one.

For those cases, it’s important to pour on the empathy. But you also want to get them to pivot from secondary to primary emotions:

Dave, it sounds like you’re frustrated about not having enough for retirement. Is that right?

Asking your clients questions often helps move them from an emotional state to a more rational one where they are better able to listen.

Action. Once your clients feel heard, pivot them toward action:

That makes sense, Dave. This kind of time is hard for many clients to weather. In addition to rerunning your financial plan to see your current projections, what else do you think we should consider doing?

While a question like this may provoke your clients to suggest some action they shouldn’t be taking, it’s better to have them express it so that you can defuse that bomb.

You might also recommend some nonfinancial actions:

Dave, even with this drop of 28 percent, you’re still on track to meet your goals. I know it can be hard to sit by and watch a portfolio, so most of my clients find it helpful to come up with a short list of things they enjoy doing to get their mind off it. You’ve mentioned cooking and tennis in the past—is there a third activity you often enjoy?

Confidence. Finally, leverage your own confidence as a steadfast coach and partner to your clients. You might start this way:

Whether due to the market, illness, or any other hardship in life, I have been side by side with my clients for 16 years and counting, and I’m not going anywhere. I know this feels frustrating and nerve-wracking, but just know that I’m here with you in this. And I’ve seen you work through some tough stuff; I know that you are strong and smart and will continue doing the prudent things that have served your family for all of this time.

In any difficult conversation, I like to imagine that my goal is my lifeboat. The further I get away from that goal, the more likely I am to drown. In some conversations, your goal will be to preserve the relationship, even if that means giving a bit on the asset allocation. In others, it will be to hold the line to protect clients' futures.

Ahead of or during any tough conversation, figure out your ultimate goal. If you find yourself adrift, simply announce your goal to your client:

Dave, I apologize for letting us get off-track. You called with concerns about your portfolio, and my goal here is to make sure that we make a decision we won’t later regret. Let’s talk about the pros and cons of each of our options.

There is a term in the medical field called compassion fatigue. It happens when you spend so much time and energy empathizing with others, without taking care of yourself, that you get overwhelmed. And it’s common in the advisory field as well. Much like you may guide clients to feel better with tennis, cooking, meditation, napping, spirituality, family, and so on, make sure you have a plan to nourish yourself.

By preparing your clients—and yourself—you’ll be well equipped to manage clients the next time their risk perception skyrockets, whatever their risk tolerance.

What strategies do you use to manage your clients' risk perception? Do you have a plan for nourishing yourself? Please share your thoughts with us below.