Understand the willingness and ability of customers to take risks

When developing a reliable investment portfolio for individual clients, financial advisors must consider the key factors that help to develop the most appropriate investment strategy. In the final analysis, the main concern is the realization of the client’s financial goals, and the key consideration is the client’s willingness and ability to take risks in order to achieve these goals. There are many basic aspects that are closely related to these issues, and every financial adviser must check these aspects before building a sound investment portfolio.

The willingness and ability to take risks may not always match. For example, the individuals with high assets and low liabilities in the above example may have higher risk tolerance, but they may also be conservative by nature and have a lower willingness to take risks. In this case, different willingness and ability to take risks will affect the final investment portfolio construction process.Suitable investment that suits investors’ wishes and The ability to take certain risks (personal circumstances). Both standards must be met at the same time. If an investment is appropriate, it is not enough to say that investors are risk-friendly. They must also be in a financial situation to seize certain opportunities. It is also necessary to understand the nature of the risk and the possible consequences.

Key points

  • As a responsible financial advisor, you should always make appropriate investments for your clients based on their willingness and ability to take risks.
  • Risk tolerance measures the subjective aspects of risk tolerance, including the personality of the customer, their response to actual or potential losses, and what their goals and priorities are.
  • The ability to take risks or the ability to measure objective factors, such as time frame, age, income needs, and family status.
  • Other risk-related issues stem from liquidity and taxation. Advisors should pay attention to these issues when calculating the overall risk of the investment portfolio.

Risk tolerance

Risk tolerance is often confused with risk tolerance, but the reality is that although the two are similar and related, the two concepts are completely different. Perhaps the easiest way to understand the two is to treat them as opposites of the same coin.

When a financial adviser deals with a client’s risk tolerance, the adviser is determining the client’s psychological and emotional ability to deal with risks. Essentially, this aspect of risk management is to understand and respect the level of investment or financial risk that customers are willing to bear, or the degree of uncertainty that customers can withstand without insomnia. Generally, the level of risk that a customer considers acceptable varies with age, financial stability and safety, and the investment goals that the customer wants or needs to achieve. Advisors sometimes use questionnaires or surveys to better understand the degree of risk in investment methods.

The willingness to take risks refers to the degree of personal risk aversion. If a person expresses a strong desire not to see a decline in the value of the account, and is willing to give up potential capital appreciation to achieve this, then the person’s willingness to take risks will be very low and he is a risk averse. On the contrary, if a person expresses a desire for the highest possible return and is willing to tolerate large fluctuations in account value to achieve it, then that person will have a high willingness to take risks and be a risk seeker.

Risk tolerance

The other side of the coin is the ability to risk, or the ability to take risks. This is more like an objective financial numbers game. Financial advisors must review the client’s investment portfolio, consider financial indicators that indicate the bottom-line level of risk that the client can withstand in the event of potential losses, and compare them with the potential gains of risk in terms of possible capital gains. Risk tolerance is subject to multiple Restrictions in this regard involve customers’ potential demand for liquidity or quick access to cash, and how quickly customers need to achieve their financial goals.

The ability to take risks is assessed by reviewing the individual’s assets and liabilities. People with more assets and less debt have a strong ability to take risks. Conversely, individuals with few assets and high liabilities are less able to take risks. For example, individuals with adequately funded retirement accounts, adequate emergency savings and insurance, and additional savings and investments (without mortgages or personal loans) may have a high ability to take risks.

Other matters needing attention

Liquidity risk

Liquidity risk is usually the main concern of customers. The ability to quickly sell assets and convert them into cash is not always necessary, but most investors are still gratified that they have the ability to pay unexpected or unexpected expenses, such as medical emergencies. The risk lies in the type of investment the client holds. For example, a financial adviser may provide private equity investment advice to clients who are less concerned about obtaining cash quickly, weighing the potential for significantly higher returns. On the other hand, customers who are concerned about liquidity will benefit from investments in exchange-traded funds (ETFs) and stocks, which can easily be liquidated at fair market value.

Tax issues for investors

The financial adviser must also determine how to properly structure the client’s investment account based on any tax issues that the client may have. This is mainly based on the client’s time frame and investment goals.

For example, suppose a customer is setting up an investment account to save for retirement and wants to defer the tax payment of the customer’s investment until the customer retires. Most clients prefer to postpone their taxes until retirement because they are usually classified as much lower tax brackets because the income they earn is much lower than their income during active work. For clients in this situation, the best course of action that a financial advisor can take is to set up an investment through a tool, such as a Roth IRA account, which usually allows tax-free and penalty-free withdrawal age 59 1/2 after the client reaches. However, for customers who expect to withdraw investment capital frequently before retirement, there is no benefit to investing through tax-deferred investment accounts.


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