Should a financial advisor ask me for my risk tolerance, then invest accordingly? Or do they use their own proven strategy?
This question sets up a false dichotomy. These risk-related investing considerations are not mutually exclusive.
Many financial advisors or wealth managers should be able to balance their investing insights with your risk tolerance. Additionally, they should explain to you why and how they are setting up your portfolio, so you don’t panic during market downturns.
For more insights on this, I reached out to financial advisors for their approaches to weighing client risk tolerance against their own investing strategies. (If you have additional questions about how risk plays into your investing strategy, this tool can help match you with potential advisors.)
Determining Risk Tolerance
“Risk tolerance is how much risk an investor can stomach,” says David Shotwell, president and certified financial planner at Shotwell Rutter Baer.
Advisors often ask clients to complete a questionnaire to gauge their risk profile and provide other financial details. If you’re working with a fiduciary financial advisor, expect to fill out this formal assessment of your risk, goals, timelines and other factors.
While the results of this survey won’t be the only variable in your financial or investment plan, they should be a factor. (If you have additional questions about how risk plays into your investing strategy, this tool can help match you with potential advisors.)
Understanding Risk Capacity
A client’s risk capacity, or his or her ability to take on risk, is another important data point when determining asset allocation and investment strategy.
“Risk capacity is how much risk works for an investor’s situation,” Shotwell says. “The advisor should determine that as part of the planning process.”
A Financial Advisor Typically Considers Risk Tolerance and Risk Capacity
Financial advisors often consider your risk tolerance and risk capacity in combination when creating a financial plan.
“When risk tolerance and risk capacity line up similarly, decisions on portfolio design may be straightforward,” says Edward Jastrem, chief planning officer at Heritage Financial Services.
“But if risk tolerance and risk capacity deviate, more thoughtful conversations may be needed to realize the desired outcomes,” he adds.
(If you have additional questions about how risk plays into your investing strategy, this tool can help match you with potential advisors.)
What If Your Financial Advisor Doesn’t Give a Hoot About Your Risk Tolerance?
If an advisor doesn’t care to identify your risk tolerance and capacity, it may mean a few things.
First, analyzing your risk tolerance may not be in this person’s job description. “If someone is a portfolio manager (for example, someone that manages a small-cap portfolio), the client may consider that person a financial advisor, but that advisor doesn’t really care about the client’s risk tolerance,” says Jon Swanburg, an investment advisor at TSA Wealth Management. In that case, it would be up to you to diversify between different asset managers to achieve an appropriate allocation.
But if you’ve hired an advisor to create an overarching financial plan or investment strategy, she should be interested in your risk tolerance, time horizons or financial goals. If she isn’t, consider walking away. Even if those aren’t the sole factors in building your financial plan, they matter and may impact how you react to market downturns.
Additionally, if this advisor is promising a “guaranteed” low-risk, low-return strategy, consider it a red flag, Swanburg says. (If you have additional questions about how risk plays into your investing strategy, this tool can help match you with potential advisors.)
A financial advisor or wealth manager should understand your investing timelines and stomach for risk while taking the time to explain and tailor her strategy to your financial situation. An advisor promising low-risk, high-reward products or refusing to listen to your concerns may be a red flag.
Tips for Finding a Financial Advisor
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Consider a few advisors before settling on one. It’s important to make sure you find someone you trust to manage your money. As you consider your options, these are the questions you should ask an advisor to ensure you make the right choice.
Susannah Snider, CFP® is SmartAsset’s financial planning columnist and answers reader questions on personal finance topics. Got a question you’d like answered? Email [email protected] and your question may be answered in a future column.
Please note that Susannah is not a participant in the SmartAdvisor Match platform and is an employee of SmartAsset.
Photo credit: ©Jen Barker Worley, ©iStockPhoto/courtneyk, ©iStockPhoto/recep-bg