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Creating the Right Client Profile

Financial Advisor

By Scott MacKillop | January 2, 2018

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Do you want to differentiate your firm from the competition while adding value to your client relationships? Then you should focus attention on an area that is ignored by most advisors: client profiling.

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Few advisors think of this as an area where they might add value, but it presents them with a great opportunity to stand out in a way their clients will understand and appreciate.

If you’re wondering how client profiling could possibly be worth your attention, then you haven’t been exposed to the research of Shachar Kariv, a professor of economics at UC Berkeley. I heard him speak at a Garrett Planning Network conference and I got a deeper dive into his research at a UC Berkeley Executive Education session in New York. Here are highlights of what I learned.

Client Profiling—A Three-Dimensional Challenge

Your job as an advisor is to understand and balance three dimensions common to every client: their goals, constraints and preferences. To do this at a high level, you need to explore each area separately and document your findings.

Goals. Most clients have multiple goals. These should be identified and prioritized. Few clients can effortlessly list and rank their goals, so asking them to provide this information in response to a simple questionnaire is not likely to produce reliable results. Developing an understanding of their true goals and their relative importance requires a more iterative process.

Start with a conversation. A skilled advisor can guide clients through an exploration of their hopes and dreams for the future. But using tools to help organize the conversation and prioritize goals makes the process more efficient and produces more consistent and reliable results. Clients often do not have sufficient resources to meet all their goals. Understanding the relative priority of goals allows you to provide better advice when trade-offs are necessary.

Developing a more comprehensive understanding of your clients’ goals will give you an edge over virtually all digital advice solutions and many of your human competitors.

Constraints. Step two is understanding the constraints that affect your clients’ ability to reach their goals. The most common constraints are on their time and their current financial assets. Most advisors are pretty good at collecting the facts about assets and liabilities. But many don’t take the time to link the achievement of a client’s various goals to specific pools of assets.

A plan for achieving each goal should be developed by taking into account client assets, liabilities and time horizons. By linking goals and constraints, you will keep your advice grounded in reality, build trust and keep yourself from making recommendations that show you did not take the time to understand the client’s unique situation and needs.

Preferences. Then there is the challenge of discovering and cataloging a client’s preferences. “Preferences,” in this context, is an umbrella term that includes emotional and cognitive characteristics that affect how the client perceives the world and makes decisions. Understanding preferences improves your ability to provide advice a client can live with.

Capturing your clients’ preferences requires creation of a “behavioral portrait.” This is hard work. Many advisors have a passing familiarity with the basic concepts of behavioral finance, but few have an in-depth knowledge of this topic and even fewer are trained psychologists. For the most part, advisors are left to feel their way toward understanding client preferences because there is a dearth of tools with a solid scientific foundation to help in this process.

A Behavioral Portrait of Each Client

The industry has traditionally used risk tolerance questionnaires to create behavioral portraits of their clients. Until recently, these were the only tools advisors had available, and they have become quite pervasive. But research has shown that questionnaires have a number of inadequacies.

First, “stated preferences” about risk tolerance are not particularly reliable. Clients are notoriously bad at understanding and reporting their own risk tolerance. Many don’t even understand the concept, and so have difficulty responding meaningfully to questions about their own behavior. What’s more, their tolerance changes over time.

The practice of assigning a client to a portfolio given only their risk tolerance is becoming commonplace, but it’s suboptimal. Focusing on risk without considering client goals and constraints is an unbalanced approach. It’s like trying to make a suit for a person whose height you know, but whose waist and chest size you don’t.

Another problem with designing a portfolio this way is that risk tolerance is only one aspect of a client’s risk persona. There are four aspects, and each needs to be considered in advising the client.

The first is their “risk requirement”—that is, the amount of risk they should be taking if they want to reach their stated goals. If they have $500,000 today and want $1 million in 10 years, you will have to calculate the amount of risk they must assume to stand a reasonable chance. It is essentially a math problem.

The second is “risk capacity.” That means the amount of risk they can afford to take given their current constraints on time and financial resources. Theoretically, clients with aggressive goals, few financial resources and a short time horizon should take lots of risk to have any mathematical chance of reaching their goals. But realistically, they probably shouldn’t. Given their narrow time horizon, they simply don’t have the capacity to recover from significant losses, which are a distinct possibility if they pursue aggressive investment strategies.

The third is “risk tolerance.” Professor Kariv’s research suggests that a person’s risk tolerance actually has multiple components. They include “risk aversion,” “loss aversion” and “ambiguity aversion.” Let’s look at each one separately.

Alex Honnold ascended the 3,000-foot granite wall known as El Capitan in just under four hours without ropes or safety equipment. For someone else, a brisk one-hour bicycle ride on a paved path is pushing the limits. Honnold is less risk averse than our bicycle-riding friend.

Loss aversion is a separate and distinct component of risk tolerance. People vary in how they weigh the potential for gains and losses and in the way they react to losses once they occur. Even a bold adventurer like Honnold could be quite loss averse when it comes to investing and our bicycle-riding friend could surprise us by taking extreme market volatility in stride.

How a person deals with ambiguity is another distinct component of risk tolerance. A person who deals well with known risks may not be as comfortable making decisions in an environment of uncertainty. Honnold studied and trained for years for his El Capitan ascent. He knew precisely the nature and magnitude of the trial he faced. He could calculate his odds of success. But that does not mean that he would be comfortable committing a large portion of his net worth to the vagaries of the market.

To appropriately tailor the advice we give clients, we should understand the multiple components of their risk tolerance. We should understand their willingness to take on risk, their aversion to loss and their aversion to ambiguity. These are all measurable.

The fourth aspect of a client’s risk persona is “risk perception.” This refers to the person’s attitudes about the likelihood of bad events occurring. Optimists see the possibility of bad events occurring as less likely. Pessimists see them as more likely. Knowing where your clients stand can help you better counsel them before and after bad events.

An Opportunity to Stand Apart

Professor Kariv’s research shows that we still have a long way to go in understanding our clients and being able to appropriately advise them given their unique goals, constraints and behavioral characteristics. Yet understanding how your clients make decisions and how they are likely to react in times of stress is crucial to designing plans and portfolios for them.

In response to the need for a better profiling tool, Kariv and his colleagues have developed “TrueProfile,” a program that incorporates the concepts underlying his research. You can learn more about his research at

Think of client profiling as a separate part of the client on-boarding process. Develop a strategy, tools and work flows to support that process. Spend the time necessary to understand the needs and characteristics of each client so you can offer the services and support that is most likely to get them to their long-term goals. Your clients will appreciate it because client profiling puts them, rather than their plans or their portfolios, at the center of the process.