Tom Lydon, CEO of ETF Trends, recently met with Aaron Klein, co-founder and CEO of Riskalyze, to discuss volatility and risk in current markets, particularly with Ukraine and Russia’s geopolitical tensions.
Klein opens by discussing his background in an options brokerage firm and the genesis of Riskalyze through the need that he and his fellow co-founder Mike McDaniel, a financial advisor at the time, saw for advisors to understand risk better as it pertains to their clients and portfolios.
“When we dug into it, we realized there was just so much about this profession that was based on these qualitative terms like conservative and moderate and aggressive,” Klein says, adding that there was no real way to measure those terms and understand them universally.
The risk methodology that Riskalyze uses is one that was built around helping advisors create a short-term framework for their clients to better understand risk so that they would react better in times of increased market risk. Through better understanding, a fearful investor that might make poor decisions can instead become a more fearless one who makes optimal decisions in times of market stress.
Clients answer a series of questions created by Riskalyze to determine their personal risk score between 0-99. Then advisors can take that number and show them the level of risk they are carrying in their current portfolios and any mismatch that may exist.
“For a lot of those advisors, they’re meeting with their prospective client, the clients are risk 45, and it turns out their portfolio is a risk 82. That client, all of a sudden, sees it, they go, ‘That’s why my portfolio is bouncing around more than I feel comfortable with,’” Klein explains.
The reverse can also be true with clients who have more risk tolerance but are unhappy with the performance of their low-risk portfolios. Understanding the risk levels that they are comfortable with helps clients to better understand and be comfortable with how their portfolio will react and perform in times of higher market volatility like today.
The Difference a Framework for Risk Can Make for Clients
Having regular check-ins with clients to review their portfolios and discuss their risk ratings while helping them to understand the historical range of their portfolios’ performances will make them less likely to panic when market volatility happens. As long as their portfolios are still falling within the bounds of their historical performance ranges, these better-informed and risk-aware clients know that they will most likely recover over the long term to align with the risk ratings they are comfortable with.
“It really does tamp down those client concerns, and it gives the financial advisor a really great language to level-set that when the client does call,” Klein explains.
The system works by giving a portfolio a 95% operating range of above and below performance that is considered normal based on historical performance. It helps clients understand that deviations within those bounds are to be expected, but also that sometimes there is a 5% chance that the portfolio could drop below those bounds or rise above, but that those instances should be rare.
“That 95% range, one of the things I like to say is that it flips the advisor from losing 95% of the time to winning 95% of the time with their clients,” Klein says. Instead of clients constantly wondering why their portfolios underperformed an estimated return or else perhaps didn’t capture all the gains that the market might have, now they have an understanding of the range that their portfolios will operate within, even during times of volatility, creating a relationship of trust in the system and their advisors.
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