Aaron Klein had a career at the intersection of finance and technology, running a global product as an addition of an auctions brokerage firm. In March 2011, he established Riskalyze to provide financial advisors with a quantitative measurement of client risk tolerance.
In the interview, we discussed the issues of risk assessment, how it can help advisors and investors to make investment decisions, and what challenges arise with generational wealth transfer.
The weakness of standard risk assessment
Aaron believes that qualitative risk questionnaires are largely unhelpful due to the following main reasons. First, people have a propensity to answer the same question differently based on their frame of mind on any given moment. In addition, the questions are rarely applicable to the solutions. Aaron says:
“The only way that the typical qualitative questionnaire gets any kind of stability out of the answer is that [it is based] on the investor’s age [and] time horizon. If you’re young, you’re probably aggressive; if you’re old, you’re probably conservative.”
According to Aaron, some questionnaires include market sentiment questions, such as “Do you get a thrill out of investing?” or “If your portfolio was a car, what kind of car would it be?” Aaron doubts that the answers can truly assess investors’ risk tolerance.
Using social media for risk assessment
Lately, it has become a trend to gather information about individuals from social media and use big data analytics and machine learning to offer better solutions for clients. Aaron says that at Riskalyze they have also tried to utilize this approach. However, the idea turned out to be inefficient for risk assessment.
Aaron provides the following example. The system obtains information about somebody’s brokerage account and sees that the investor owns some stocks in Facebook. But if Facebook goes into free fall and the investor sells their Facebook stocks, what does this mean?
“Are they risk averse, or are they risk seeking? Did they sell [their] Facebook [shares] because it was part of a recent plan to have an exit from the stock at a predetermined price, or did they sell […] because they panicked, got fearful, and sold at exactly the wrong time?”
From the brokerage account and from posts on social media it’s impossible to define why the investor did this and what their frame of mind was. This is why the team at Riskalyze saw this as a deeply flawed approach, and discarded it.
Aaron highlights that at Riskalyze they believe in a quantitative approach to asking questions based on dollar amounts relevant to the individual. Moreover, they bring the question of risk down to what an investor is willing to risk in their personal financial spectrum. In this way, the answers become stable whenever they are asked.
How can rebalancing be enhanced?
Aaron states that he very often hears from customers that they use a certain rebalancing solution that turns out to be inefficient, so they end up editing every trade.
Sometimes rebalancing is very manual—it requires a lot of programming, configuration, and setup—and then advisors are still not really sure that what they’re getting on the other end is what they expect.
This is why when the Riskalyze team thought about rebalancing and automated trading, they wanted to revolutionize the approach. Riskalyze’s Autopilot system does more than just implementing advisors’ decisions; it keeps the accounts on track using an investor’s Risk Number, which it compares to the Risk Number in their portfolio.
Is financial planning required?
Aaron mentions another issue that financial advisors have: financial planning. This is time intensive, which is why advisors usually charge a separate fee for the service, but many clients aren’t willing to pay it even though planning may help them significantly.
Riskalyze offers a Retirement Map, which is not a financial planning tool, but helps advisors to interest their clients. The tool allows advisors to show their clients how their portfolio will evolve if they make certain investments on a regular basis, and how much money they might have for their retirement. Since many individuals still want to allocate money to areas besides investing for retirement, such as buying a house, they may need to plan their finances to be able to meet all their goals. This is when advisors may offer financial planning services.
“What we hear from our advisors who do financial planning is that [the Retirement Map] has actually helped them drive that part of their business and got more of their clients to do financial plans because the Retirement Map helped the client to start thinking down that road.”
How Riskalyze helps advisors
Talking about industry trends, Aaron points out that observing them helps the company make decisions. He feels that advisors are using more digital, automated solutions, and are starting to prefer quantitative models over qualitative.
“I think that risk is the lens through which the advisor of the future makes decisions because the best way to manage an investor’s behavior is to make sure the investor understands what’s coming in terms of risk, and [to ensure he or she] understands how to react to risk appropriately.”
This is where Riskalyze found their niche, and are now well positioned for the near future. According to Aaron, the company helps advisors in the following areas:
- Driving engagement and alignment between clients and their portfolios.
- Building better portfolios through the lens of risk.
- Automating how they serve their clients.
As a result, advisors may offer better services while spending less time.
“[The] number of hours spent per client account currently averages about 14 per account per year. And that’s how we can democratize access to advice and give advisors the ability to profitably serve clients with less than 250,000 dollars.”
Wealth transfer between generations
Aaron doesn’t see anything special or new about wealth transfer—it’s always happened. The only challenge for advisors now is to efficiently communicate with the next generation, to build relationships with them.
“I think that far too often the biggest challenge that advisors face is they don’t demonstrate to the next generation that they’re capable of looking at people as individuals who might want to manage things differently.”
Riskalyze’s Risk Number may really help advisors demonstrate that they can deliver personalization to the next generation. Children may have a different Risk Number from their parents, or have different goals and earnings, which may lead to quite different portfolios.
Interviewed by Vasyl Soloshchuk, CEO and co-owner at INSART, FinTech & Java engineering company. Vasyl is also the author of WealthTech Club, which conducts research into Fortune and Startup Robo-advisor and Wealth Management companies in terms of the technology ecosystem.