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156 Focus Sessions: Practice Management How to Convert Client Anxiety About Risk into Business-Building Strategies Michael T. Carpenter Welcome and congratulations on your decision to attend this Focus Session on risk, risk management, and how to convert client anxiety and concerns about risk into powerful business-building forces. Since risk is often seen as complex and highly quantitative, and a not very pleasant, fun, or exciting subject area, most people prefer not to spend much time thinking about it. However, anyone not thinking about risk does so at great peril. Not addressing risk and how to manage it effectively will condemn them to a life in which risk controls them rather than they control risk. So congratulations on joining us today. Being here is a testament to your appreciation of the importance of gaining knowledge in this increasingly important subject area as well as of the many benefits of investing your time, attention, and energy in understanding and managing risks better. Count the Fs To begin, let’s take less than a minute for a brief, fun, and enlightening exercise. It’s called “Count the Fs.” Let me share with you how this short-timed exercise will work. First, you’ll need to have a pencil or pen in your hand and a piece of paper to write on. Everyone ready? Shortly, I’ll place a slide on the screen that has a title and a brief three-line sentence. Once I do, you’ll have 15 seconds to read the three-line sentence on the slide and count the number of times the letter F appears in the sentence. Please do not count the Fs in the title above the sentence. Only count the Fs in the sentence itself. Once I say to stop at the end of 15 seconds, I’ll switch the slide off and ask you to write the number of Fs you counted on the sheet below the sentence. Then we’ll discuss it. Everyone have your writing instrument and paper ready? Great. Here’s the slide. Begin. Now stop and write the number of Fs you counted below the sentence. [visual] Okay, we’re now ready to review the results. How many of you counted three Fs? How many four Fs? How many five Fs? How many six Fs? The fact that there are actually six Fs, when so many attendees counted only three Fs, usually shocks and surprises those who did not count all six of the Fs that are in the sentence; they were right in front of their own eyes but were overlooked. This exercise is a wonderful example of how easy it is to overlook something right in front of our own eyes. This exercise is also a very simple example of just one of our many hardwired brain bugs, a sample of how many people can easily overlook obvious business-building opportunities and how many people can miss seeing risks that are right in front of them. That’s why, in spite of the enormous uncertainty, anxiety, and concern about risk that exist in all parts of the world, very few professionals see the incredible opportunity in helping people meet their needs to better understand and manage risk in a holistic, user friendly, and empowering way. A Perfect Business-Building Initiative Before we get into the subject, I’d like to ask your help with a simple but very important exercise, one that will help focus our discussion and get your mental machinery warmed up. If you could design the “Perfect Business-Building Initiative,” which would help you do an even better job for your clients, leapfrog ahead of your biggest competitor, attract new Michael T. Carpenter Carpenter is a thought leader, consultant, speaker and author of the globally published book The RiskWise Investor: How to Better Understand and Manage Risk. His Risk-Wise method can demystify risk and reduce the likelihood and impact of painful, negative surprises for businesspeople, professionals and investors. He started his career as a financial advisor and advanced to regional- and national-level positions with PaineWebber. Carpenter then led national distribution teams for John Hancock Funds, Transamerica/IDEX, MFS, and Rydex before starting his own consulting firm in 2003. Carpenter Associates P.O. Box 306, Concord, MA 01742 phone: +1 978.369.5711 email: [email protected] Order a copy of the presentation on www.mdrtpowercenter.org: MP3: MP1235 CD: C1235 Annual Meeting Proceedings | 2012 ©Million Dollar Round Table How to Convert Client Anxiety About Risk into Business-Building Strategies business more easily, and take you to new levels of personal, professional, and financial success, what characteristics would such a perfect business-building initiative have? The Perfect Business-Building Initiative would offer: 1. A totally new, different service 2.A way to meet an enormous and growing unmet worldwide need 3.A unique competitive advantage that helps you stand out from the competition and establishes you as thought leader and go-to resource 4. The ability to attract increased demand for your products and services in a new way, one that neutralizes your competition 5.Improved impact and effectiveness of your existing sales and marketing resources 6.A long and effectively limitless shelf life 7. The ability to build client trust and confidence more quickly and easily 8.Another source of revenue and income that enhances your existing business 9. A proven way to become a high-net-worth client magnet 10. The ability to gain the respect and support of centers of influence 11.Easy to implement into your practice 12. A way to have increasing uncertainty and the accelerating pace of change to help your business grow rather than frustrate it That’s a pretty powerful set of characteristics. Do you think a business-building program that had those characteristics would help your business? Given the reality that there are no perfect business-building programs, what we’ll be reviewing over the next hour comes closer to meeting those characteristics than any business-building initiative I’ve seen in my many decades of financial services sales and marketing experience. The phenomenal opportunity I’m taking about is positioning yourself as the go-to resource in helping people everywhere meet the enormous and growing worldwide need to better understand and more effectively manage the uncertainty and risks of our rapidly changing and increasingly less certain world. Slightly repositioning your business in this way will open up a treasure trove of additional business opportunities, increase the likelihood of your clients reaching their objectives, and help you to stand out above the competition and do a great deal more insurance and other business as a side benefit. ©Million Dollar Round Table Of course, to help our clients and prospective clients better understand and manage risk, we must first understand risk and how to manage it effectively ourselves, and then we can help our clients do it. So let’s now focus on how to understand risk better, how to manage it effectively, and finally, how to integrate risk education and risk management planning into our business. Understanding Risk First, let me ask you: Is the world getting riskier, or is it getting safer? Actually the world is getting both safer and riskier at the same time. Some risks that we’ve lived with for a long time are getting safer because the more we’ve lived with them, the better we understand and control them and have learned how to minimize their negative aspects. Some examples include quality of life, life expectancy and longevity through improvements in health care (medicine/surgery/pharmaceuticals), commercial aviation, fire protection, auto safety, and the dangers of pollution. However, our world is also riskier in other areas. As our world progresses and changes, new risks, rare risks, unexpected risks, and unintended consequences appear that we’ve never seen or dealt with before, for instance, space junk falling from the sky, the Three Mile Island and Chernobyl accidents, the BP oil spill, the mortgage meltdown/financial crisis, 9/11 (terrorism), the Japanese tsunami/Fukushima nuclear disaster, computer viruses and worms, botnets, cyberwarfare, entire cell phone/computer networks that go down without notice, paperless banking, and cloud computing. Things that aren’t supposed to happen are happening more and more frequently. They pop up, out of the blue, and shock, surprise, and concern us. Because of their ferocity and devastating effect, coupled with the fact that we didn’t know they were risks in the first place and have no idea how to deal with them, they generate increased anxiety, fear, and even panic. So the risks we face are both increasing and decreasing at the same time. What Causes Risk? Another basic question about risk is, what creates, drives, or causes it? Rapid Change What generates risk is any situation that begins changing rapidly. The faster and more violently it changes, the greater the risks it generates. Annual Meeting Proceedings | 2012 157 158 Focus Sessions: Practice Management We find rapid change unpleasant and unsettling because it increases our uncertainty, and we don’t like too much uncertainty, although we do like predictability with a little bit of change thrown in (because otherwise things can get too boring and uninteresting). However, we don’t like too much change too quickly and tend to resist it. (with the exception of the Dark Ages), and it is most likely to continue. The only difference is that we’ve now entered into the exponential phase of the pace of change curve. Let me give you just a few examples of how the pace of change is accelerating: • China will soon be the largest English-speaking country in the world. • The 25 percent of India’s population with the highest IQ is larger than the total U.S. population. (India has more honors students than the U.S. has children.) • The top 10 in-demand jobs in 2008 did not even exist in 2004. • The U.S. Department of Labor estimates that today’s learners will have 10 to 14 jobs by the age of 38. • One of four workers has been with his or her current employer less than one year (for one of two workers, it is less than five years). • There are more than 36 billion searches on Google every month. In 2006 this number was 2.7 billion. To whom were these questions being addressed before Google? • These are the years it took to reach a market audience of 50 million: for radio, 38 years; for TV, 13 years; for the Internet, 4 years; for the iPod, 3 years; for Facebook, 2 years. • A single week of The New York Times contains more information than a person was likely to come across in a lifetime during the eighteenth century. • By 2014 a computer will be built that exceeds the computational capability of the human brain. • Predictions are that by 2046 a $1,000 computer will exceed the computational capabilities of the entire human species. (What implications for changing our lives that will have can only be imagined.) We have breached a critical “inflection point” relative to the pace of change and the risks it will generate. With the increasing speed of change, our old traditional ways of dealing with risk passively, reactively, and situationally are ineffective and no longer work in our rapidly changing, less certain world. To gain control over risks, we must face risks directly, proactively, and comprehensively; otherwise, risks will control us. Given That Fact, What Do You Believe Is Going to Happen to the Who’s Your Client’s Chief Risk Officer? Pace of Change in the Future? In the last dozen years, virtually every large enterprise in the world has recognized the vital need to be much more proactive in managing the increasing risks associates with rapid change. As a result they’ve created a new C-suite executive- Is the World Really Changing That Rapidly Today? Absolutely. We now live in the most rapidly changing period in human history. Many people see the world as analogous to an unguided missile, shooting off into the future with more speed than control. Rapid change is taking place in every aspect of our lives, from technology and communications to medicine and health care, and from social norms, what composes a family, our definition of gender and gender roles, the role of government, the shifting of geopolitical power from the West to the East, globalization, the rising influence of the developing countries, accelerating globalization and the increasing interconnectedness of everyone and everything, the food we eat and where and how we eat, to the environment, where and how we work and retire, and even how we spend our golden years. There isn’t a subject, discipline, field, or person that isn’t affected by rapid change. In fact, when I was in college, one of my history professors mentioned that in ancient China one of the worst curses you could inflict on anyone was to say, “May you live interesting times.” That was because the normal, highly predictable lives of the people in those times changed very little from day to day, season to season, year to year. Their lives got interesting when there were unpleasant changes generated by famine, invasions, disease, or natural disasters that complicated their lives. Change is rampant today and accelerating everywhere, in everything, and affecting everyone simultaneously. That increasing rate of change has profound implications, including the fact that it creates increased uncertainty and volatility, plus more and bigger risks and more and bigger opportunities hurtling toward us faster and faster. Have you noticed that things that aren’t supposed to happen are happening more and more frequently? How Do We Human Beings Typically React to Rapid Change? Will it continue to accelerate, moderate, slow down, or reverse? If the past is any guide, the pace of change will continue to accelerate. That’s what it’s done for the last 5,000 years Annual Meeting Proceedings | 2012 ©Million Dollar Round Table How to Convert Client Anxiety About Risk into Business-Building Strategies level position, reporting directly to the CEO, that has never existed before. Joining the ranks of the chief operating officer, chief financial officer, chief marketing officer, chief investment officer, and chief counsel is the new C-suite position of CRO, or chief risk officer. The CRO has the resources and enterprise-wide responsibility to identify and manage the risks facing the organization. Why? Because today even the best run and most successful companies could more and more easily fall victim to risks that, should they occur, could literally decimate their entire business and reputation. These entities know from experience that it is always much less costly and much more effective to avoid or prevent risks from occurring, and to minimize the impact of risks, than it is to clean up and attempt to recover after the damage has been done. With major corporations and their worldwide departments addressing the need by staffing full-time CROs to manage the risks faced by their organizations, who can individuals, families, professionals, and businesspeople seek out to help them identify, prioritize, and manage all the risks they face? Right now the answer is no one. That’s simultaneously a very big problem and a rapidly growing, enormous need, but a wonderful, wide-open opportunity for you as financial advisors to address. How much of your day do you spend dealing with risk in one form or another? Virtually every minute of every day. Although it may not seem so right now, your background gives you wonderful knowledge and an experienced foundation on which to build personalized, holistic, comprehensive risk management planning into your practice. All you need to do is become a little more familiar with the fundamentals of risk, risk management, and risk management planning and preparation. Financial Professional “Risk-Wise” Quiz As a first step in that process, and to serve as a discussion outline, I’d like to invite each of you to test your financial professional risk IQ. This is a brief, timed, nine-question, self-graded quiz that will serve as your first step in building a reputation as the trusted go-to resource for helping your client target market better understand and manage risk, reduce the likelihood and impact of unpleasant negative surprises, plus easily determine which risks to avoid, accept, and manage, or accept outright with no risk management. You’ll find it a very helpful and enlightening exercise. As we review the quiz slides, please number the nine questions and write down your answer for each one. Plan on ©Million Dollar Round Table spending no more than 20 seconds on each question. We’ll then discuss each question once you’ve had the chance to record your answer. Ready? The Financial Professional “Risk-Wise” Quiz Test your personal “Risk-Wise” IQ. Please write your answers below each question. 1. What is your definition of risk? 2.Risk and reward are equally balanced. ____ True_____ False 3. What is the primary objective of investment management? 4. Name the two basic approaches or schools of risk management. and Which one is best? 5. What are the three basic types or states of risk? 6.Where does the primary work of risk management take place? 7.Year in and year out, which profession is consistently ranked worldwide as the most trustworthy? Why? 8.What is the probability of a major, gut-wrenching, surprise stock market decline of 4,000 points or more (30 percent plus) in the DJIA within the next four to six years? 9.A proven method for turning risks into inconveniences, and even opportunities, is what? How did you do? Do any of you feel like you got a score of 100 percent? Did you find it easy to complete or challenging? Don’t feel bad. I began my research into risk and risk management because I felt that as a financial professional I should know a great deal more about the subject than I did. When I began my quest, I couldn’t easily or Annual Meeting Proceedings | 2012 159 160 Focus Sessions: Practice Management confidently answer any of those questions. However, knowing and applying the answers can help you become a more confident, professional, and successful financial CRO and meet the enormous and growing worldwide need of people everywhere to better understand and manage rapid change, uncertainty, anxiety, and concerns about risk. Let’s review the quiz answers together. 1. What is your definition of risk? Most people don’t think about risk very much and have to struggle to define it. When they do articulate a definition, they generally define risk as the loss of something; something bad happening; falling short of an objective; or, in the investment world, as unexpected volatility, standard deviation, or a hazard or a threat. However, those are the results or secondary or even tertiary consequences of a risk occurring, not the risk itself. Defining risk by its consequences is analogous to doctors treating the symptoms rather than the causes of disease. One of the first things that new medical students learn is to use symptoms as clues in helping to identify the cause, rather than to treat the cause. If only symptoms are treated, the patient is never going to be cured. It’s the exact same thing with risk. Defining risk as “the degree to which an outcome varies from what you expected” is empowering because we have a great deal of control over our expectations (both good and bad), and the more realistic our range of expectations, the easier it is to identify and prioritize the potential risk we face and then determine which risks we want to avoid, accept, and manage, or accept without risk management. Why is it important to have a well-thought-out definition of risk? Because how you define anything is the frame through which you view it. The definition you use can either complicate or frustrate your understanding and how to deal with your subject, or it can be empowering and make understanding the fundamental nature of your subject easier. When it comes to risk, the basic definition you use is the critical foundation on which your entire risk management approach will be built. With a strong and solid foundation, what you build will make your risk management job easier and more effective, serve you better, and stand the test of time. With a weak or inferior foundation, even the grandest, most sophisticated risk management methodologies will not work and will lead to frustration, disappointment, and unnecessary loss. Now, you may believe that I’m making a big deal out of something quite Annual Meeting Proceedings | 2012 minor. Just think a moment, however, about how the old, inferior, pre-Galileo celestial mechanics’ definition of the universe revolving around Earth would have greatly frustrated mankind’s space exploration efforts, about how the assumption of a flat Earth stifled global exploration for centuries, or even the common belief for thousands of years that humans were not meant to fly and never would. Your basic definition determines how you look at a question and is the first step to ultimate success. The frame through which you view your challenge can either complicate your efforts and restrict your success or empower and facilitate your efforts. Using the right definition is, in fact, very, very important. Although initially the simple definition of risk being “the degree to which an outcome varies from expectation” may not seem particularly profound, it is outstanding when you consider its far-reaching implications. It’s tremendously empowering because, although we have little to no control over the future, we alone determine our own expectations of potential outcomes based on our knowledge, understanding, and preparation. • Our expectation of the possibilities is under our full control, which is not the case when we abdicate control to totally random occurrences or use definitions that are actually the result of risk rather than the risk itself. • The greatest impact typically comes from those risks we don’t expect, haven’t considered, or aren’t prepared for. • This definition encourages us to think through the full range of possibilities, both expected and unexpected, while recognizing how surprises happen all the time. • We have total control over our expectations and full responsibility for them. • More realistic expectations lead directly to better and more effective risk decision making and risk management. • We have the power to ignore, accept, or prepare for what we expect. • Finally, it gives us the flexibility to deal with both negative and positive variations from expectation. 2. Risk and reward are equally balanced. True or false? The correct answer is both true and false because risk is under your control. Risk and reward are equally balanced only if all things are equal and one has no knowledge or experience dealing with a risk. However, with knowledge, understanding, and experience with that risk, plus thorough preparation, we each can tilt the risk/reward equation in our favor and pursue greater rewards with less risk. ©Million Dollar Round Table How to Convert Client Anxiety About Risk into Business-Building Strategies 3. What is the primary objective of investment management? According to institutional guru, thought leader, expert consultant, member of the Board of Harvard Business School, and author Charles Ellis, risk management is the primary objective of investment management because investing has transitioned from being a winner’s game, in which you win by spending more time, energy, and effort to uncover opportunities, to a loser’s game, such as in golf or tennis, in which you win by making the fewest mistakes. When you are competing with almost limitless time, money, and people resources and are committed to finding the best opportunities, it is easy to get caught up in the futile effort of chasing the best returns. As Donald Trump has said, if you focus on protecting the downside, the upside takes care of itself. The medical profession also embraced this same objective thousands of years ago with its commitment to “First, do no harm.” 4. Name the two basic approaches or schools of risk management. There are two basic approaches or schools of risk management: The quantitative method is based on the concept that the best way to predict and gain insights on the future is to measure and quantify relationships of the past. It is based on probability and statistics that were developed more than two centuries ago as a way to improve the odds of gambling. In order to make the numbers work, several assumptions must be made: (a) Markets are efficient; (b) investors are rational; and (c) price changes adhere to a normal bell curve distribution. This school of risk management works well in mild risk environments, but does not work at all in wild risk environments. The other risk management method is the qualitative, or subjective, method. It’s proved its effectiveness for thousands of years. Its proponents maintain that the best way to manage future risks is, rather than relying solely on quantitative relationships of the past during the most rapidly changing period in history, to use knowledge, experience, and insights into the ever-changing environment in making subjective judgments about a subjective future. Even the great mathematician and physicist Albert Einstein said, “Not everything that counts can be counted, and not everything that can be counted counts.” Which one is best? Using both can be most useful, as long as you recognize their respective strengths and weaknesses. Given that the quantitative method works best in mild risk environments and poorly in wild risk situations, and that ©Million Dollar Round Table the qualitative method works well in wild risk environments, the best alternative would be to use a combination of the two methods. Their respective strengths and weaknesses can then complement one another and deliver a better overall result in both the wild and the mild risk environment we experience in the real world. 5. What are the three basic types or states of risk? The complex and multifaceted subject of risk can be made much easier to understand by looking at risk the same way that physical scientists look at matter in the universe. The enormous variety of matter in the universe seemed very complex and confusing until we discovered that matter has three basic forms: solids, liquids, and gasses. They are the basic forms of matter. Just as understanding that water as ice has very different physical properties than water as a liquid or water as a gas, but it’s still water, risk has three states, presented below, that all behave differently: Type 1, Mild Risk—No big surprises, low variability, normal bell curve distribution, statistically based modern finance theory assumes only mild risk. Type 2, Wild Risk—Irregular, unpredictable, outside the norm, limitless, frighteningly fast, fluid from one value to the next (see data below): Price Changes in DJIA, 1916–2003 (88 years = 22,0000 days) Daily Move Bell Curve Theory Reality >3.4% 58 days 1,001 >4.5% 6 days 366 >7.0% 1 day every 300,00 years 48 -21% (Oct. 19,1987) 1 in 10 (it should never happen) 50 Source: Benoit Mandelbrot, The (Mis)behavior of Markets (New York: Basic Books, 2004). Type 3, Slow Risk—Slow, hard to identify, builds slowly over time, why we need maintenance and need to put energy into systems (order to disorder) 6. Where does the primary work of risk management take place? The human brain, with its limbic system and neocortex, is programmed to fear first and think later. Our animal brain can and often does hijack and overpower our logical, thinking brain when we feel threatened or are under stress. Erich Maria Remarque observed this in his 1929 novel All Quiet on the Western Front, which is about the extreme stress of soldiers fighting during World War I: Annual Meeting Proceedings | 2012 161 162 Focus Sessions: Practice Management By the animal instinct that is awakened in us we are led and protected. It is not conscious; it is far quicker, much more sure, less fallible, than consciousness. The premier risk management system in the world is the human brain. Our brain’s limbic system has been hardwired over hundreds of thousands of years to be an outstanding risk management system that also has the ability to learn and adapt to new situations, threats, and environments. Our risk management system is hardwired to fear first and think second. Our emotional animal brain can easily hijack and at least temporarily take control of our logical, thinking brain. That’s why it’s so important to understand that the primary work of investment risk management must take place in our brain before it’s implemented at asset allocation and then the portfolio level. Doing the opposite makes it much easier for the emotional brain’s freeze-flight-fight programming to take over and discard portfolio-level risk management at the first sign of a perceived threat. 7. Year in and year out, which profession is consistently ranked worldwide as the most trustworthy? Why? Physicians. Why? The way they talk about risk with their patients. Over many years of surveys taken all over the world, one group of professionals has consistently been ranked as the most worthy of trust, and that is physicians. Why is it that doctors are continually viewed as so trustworthy? They certainly have rigorous training, accreditation standards, licensing requirements, continuing education requirements, and strict codes of conduct and ethics, yet other professions have those as well. Their nicely starched white coats also give them an additional air of credibility. What is it that makes them so much more trustworthy than other professionals? After thinking about it for a long time, my conviction is that doctors’ reputation for trustworthiness is the direct result of how they talk about risk with their patients. Since trust is the basis of financial advice, we can learn a great deal about how to build trust from doctors. They build trust by talking about the rewards and the risk of their recommendations in a brutally frank, detailed, full-disclosure, and transparent way. With the objective of helping their patients make the best fully informed risk/reward decisions for themselves, under a great deal of uncertainty, physicians share the potential benefits of their professional recommendations, and the potential risks, and then leave it up to their patients to decide how they want to proceed. Once the patient has decided on a Annual Meeting Proceedings | 2012 certain path, the doctor then respects and supports each patient’s decision. Rather than being put off by doctors’ frank discussion of risks and side-effects, their frankness in sharing even potentially life-threatening risks make us respect them even more. How would you feel about a doctor who told you that the open-heart surgery he recommended for you was a “piece of cake” and nothing to be concerned about? You’d likely want to run the other way and find another doctor. As a result, my recommendation to you is talk about risk with your clients the same way doctors talk about risk. You are a financial professional and an expert in dealing with many kinds of risks, financial and otherwise. You can build credibility and trust more quickly by sharing your insights and helping your clients make well-informed, knowledgebased risk/reward decisions built on a foundation of full disclosure and transparency. Help your clients and prospective clients reach their financial goals, and identify, understand, plan for, and manage the risks they’ll face along the way. By doing so you’ll soon become so respected and trusted that your clients will enthusiastically recommend you to their friends, associates, and centers of influence who need help in finding a go-to resource to help them better understand and manage the risks of our increasingly less certain world. 8. What is the probability of a major, gut-wrenching, surprise stock market decline of 4,000 points or more (30 percent plus) in the DJIA within the next four to six years? The vast majority of people I speak with and ask this question of respond with a percentage guesstimate of between 60 percent and 90 percent. Although you can spend a great deal of time and money in an effort to analyze this question in detail, the market track record has demonstrated over and over again that major gut-wrenching declines occur about every four to five years. We know they’re going to happen, but we just don’t know when or why. So instead of worrying about the probability, do what the best risk managers do, and although no one knows when it will happen, assume a major market collapse is virtually certain and build that assumption into your plans. Then decide in advance what you’ll do. You may decide to ride it out, or you may decide to hedge your downside, move into a defensive position, reduce your equity exposure, and raise some cash. You may also want to consider using your dividend or interest income to build cash in a special opportunity fund that you can use to buy the stocks of firms you like at bargain-basement prices when the market is oversold, thereby lowering your overall cost basis. If you were a sailor crossing the open ocean, you wouldn’t ©Million Dollar Round Table How to Convert Client Anxiety About Risk into Business-Building Strategies set sail hoping not to run into a storm. Instead, plan for and prepare to run into a storm so that when you do, you’ll be ready. Then if you don’t hit stormy seas, it’ll be a pleasant surprise and an even better journey. Count on it and plan for it—don’t be afraid of it. 9. A proven method for turning risks into inconveniences, and even opportunities, is what? More than 150 year ago the great American thinker, writer, and author Ralph Waldo Emerson observed that “Knowledge is the antidote to fear.” It’s clear that the risks we’ve identified and fully understand and are thoroughly prepared for, with very few exceptions, can neither scare nor harm us. Identifying, understanding, and preparing for and managing risks make it possible to convert risks that do occur from becoming potential nightmares and into only inconveniences and even potential opportunities. One wonderful example of this method for converting a risk that occurs into an inconvenience is the January 15, 2009, incident known as “the miracle on the Hudson.” As a result of the professionalism of Capt. “Sully” Sullenberger and his crew, the engineers who designed and built Capt. Sullenberger’s A320 Airbus, and the training of the emergency responders, a potential disaster was converted into an inconvenience. Now that you have completed the Risk-Wise IQ Quiz, do you look at risk any differently? How? Next let’s review how to put these insights and information to work in attracting more clients and doing more business: 1.Become familiar with the Risk-Wise personal risk management planning process, which we’ll review in a few moments. 2. Become a student of risk and user-friendly, nontechnical risk management. Educate yourself and share what you learn with your clients. 3. Differentiate yourself by offering holistic, comprehensive risk management planning, and ongoing reviewing and monitoring as a complement to your financial planning, investment, insurance, and other services. It’s very easy to get started. Just end all your client and prospect conversations and calls, even if your clients have called you, by asking them how they feel about all the uncertainty and risks in the world today. Then ask what plans they have in place to manage the risks they face and how they determine which risks they should avoid entirely, which to accept and manage, and which to accept outright, with no risk management. ©Million Dollar Round Table Since the vast majority of people have no risk management plan, or even any idea of how to create one, it’s a wonderful opportunity for you to ask if they’d like your help in creating a comprehensive, holistic, and personalized RiskWise risk management plan. A personal risk management plan can help them reduce the likelihood and the impact of unpleasant negative surprises and convert risks that do occur from potential nightmares into inconveniences and even potential opportunities. With all of the uncertainty in the world today, major corporations are installing chief risk officers to address and manage the risks they face. Ask your client, “Who is your personal chief risk officer?” If they don’t have one, let them know you’d like to meet with them and apply for the job. There’s only upside and no downside in offering such a service. Even if clients decide not to create a risk management plan with you, every time that concerns about uncertainty and risk raise their heads (which they surely will), those clients will be motivated to give you a call. Now let’s circle back and review the basic steps in creating a personalized, comprehensive Risk-Wise risk management plan. Would you each consider yourself a “master of risk management”? Most people answer, no way. Well, believe it or not, you are. If you are a healthy adult human being, walking around normally day to day, you are a master at managing everyday life risks. You were born with ingrained hardwired risk management skills that over time have been enhanced by learning from others, including your parents. You learned a great deal watching and learning from others. In some cases you even learned about risk the hard way and may even still carry scars from those painful lessons. You survived the dangerous teen years when judgment flaws may have felled some of your peers. You passed into adulthood gradually gaining valuable additional life risk management skills. So you are a master of life risk management, not perfect by any means, but very effective at managing everyday life risks. You’ve done it so long that you’ve actually internalized your risk management process to the point that when asked, you, like most adults, can’t articulate the risk management process you follow. Adults typically respond that they don’t have a conscious process, that they just “do it.” What they don’t realize is that they actually have a process, although they’ve internalized it so much that it’s become automatic and they don’t have to remember it. The Risk-Wise risk management process is based on the same steps we use in our very effective, natural “life-risk” Annual Meeting Proceedings | 2012 163 164 Focus Sessions: Practice Management risk management. By reconnecting with the steps in our life risk management process and using those same proven steps to manage other risks, we can become just as comfortable and just as successful and confident at managing any risk as we are at managing general life risks. So what are the steps in the life risk management process and user-friendly, nontechnical Risk-Wise risk management planning and decision-making process? Implementing Risk-Wise Personal Risk Management Planning Preliminary Actions First, let your all clients and prospects know that what makes you different is that you offer holistic, risk management planning services in addition to insurance and financial planning, investment management, and retirement planning services. In other words, you help people reach their financial objectives and reduce both the likelihood and the impact of all types of nightmares and painful negative surprises along the way. Then review the many benefits of personalized risk management planning and ask them if they’d like to have you complete one for them. Potential Benefits of Effective Risk Management Planning • Better knowledge and understanding of risk, risk management, and oneself • Practical, knowledge-based, risk/reward decision making • Minimized negative surprises and potential missteps • Less adverse impact when risks do materialize • Improved likelihood of achieving investment/business/ individual goals • Less emotional, more realistic, and confident investor/ businessperson • Peace of mind from having a comprehensive risk management plan in place Personalized, Comprehensive Risk Management Planning Steps Personal Risk Assessment Define risk. Gain client agreement to use the empowering definition of risk introduced earlier. Identify risks. Identify and build a list of the risks that each client is personally concerned about or should be concerned about, both positive and negative. Remember to focus on the risks themselves, not on just the results or effects of the risk occurring. The critical step of identifying risk is made much easier by first becoming familiar with the two major high- Annual Meeting Proceedings | 2012 est level categories of risk and then identifying the risks each individual will face in each respective category. What are the two major highest level categories of risk? 1. External risks (risks presented by the outside world) • accidents • crisis events (natural and manmade) • economic upheavals • Black Swan events 2.Internal risks (risks within ourselves) • decision-making risks • pattern finding in randomness • misperceptions/incorrect information/assumptions • overconfidence • biases • emotions hijacking logic We’ve had a great deal of first-hand experience dealing with external risks during the last few years. Let me take a moment to share an example of one of the most important yet least recognized internal risks that needs to be identified, addressed, and managed. The “Risk Perception/Risk Reality Gap” is where we humans perceive risks to be much greater than they actually are, causing us to overreact or become overconfident and make painful judgment errors. Our human perception of risks and threats may vary widely. We frequently perceive risks to be much greater than reality and also perceive many risks to be much less that what they actually are. Understanding and recognizing this risk perception reality gap is very important when dealing with real risks. Being familiar with these perception traps allows us to be on guard against common misperceptions of risk that can adversely affect our ability to make real-world risk/reward decisions. The emotion of fear, in addition to the brain’s system that controls it, is the most understood of any of our emotions. As a result of extensive studies around the world and across all cultures, genders, and ages, behavioral scientists have found there are some characteristics that universally cause humans to see risks as much greater than reality. Situations with the following characteristics are universally perceived to be much greater than they actually are: • Large-scale consequences • Those beyond our perceived control or influence • The new, unfamiliar, or not understood • What is not expected or occurs suddenly How often do these characteristics occur in the investment markets? In the investment markets we can frequently see all four of them manifest within a 24-hour period. No ©Million Dollar Round Table How to Convert Client Anxiety About Risk into Business-Building Strategies wonder even experienced investors are unnerved in such situations. Including these and the other internal risks with the external risks you identify will make your risk management planning process much more effective. Understand risks. Understand your personal risk exposure/ context, plus the likelihood and potential personal impact of each risk. What characteristics of a risk must be considered and understood to effectively manage that risk? Most of us have become so accomplished with our own everyday, life risk management process that we’ve internalized it and don’t even have to think about it anymore. Therefore, it can be very helpful to refamiliarize ourselves with the basic factors that anyone needs to consider in order to effectively manage any risk: • Exposure/context • Likelihood • Impact • Resilience Determine which risks to avoid, accept, and manage. Prioritize risks by the potential personal impact, not their likelihood. Which of these factors is most important? • Exposure/context • Likelihood • Impact • Resilience Impact is by far the most important factor to consider when evaluating and prioritizing risks. A very common trap that many people fall victim to is focusing on, and giving priority attention to, high likelihood risks and minimizing or ignoring low probability/high-impact risks. The high likelihood risks are always grabbing our attention, focus, and risk management resources because they are so obvious. However, the risks we should give top priority to managing and planning for are high-potential impact risks, even if their likelihood is very low. The reason is that their impact can be so potentially devastating, and they should never be ignored because things that aren’t supposed to happen are happening more and more frequently. So don’t be trapped into thinking that just because the likelihood of a high-impact risk is low it can be ignored. Instead, it makes much more sense to accept or put up with the many high likelihood, low-impact risks that pester us almost daily. A simple and easy way to prioritize risks. Here, in descending order, from the most important to the least, is an example of how the various risk impact and risk likelihood combinations should be prioritized. ©Million Dollar Round Table High-Impact Risks 9.High impact/high probability—These risks will happen and must be addressed as imminent, with immediate measures implemented to reduce their likelihood, limit their impact, and recover as fast as possible after they occur. 8.High impact/moderate probability—Although the likelihood of these risks is moderate, their high-potential impact requires measures to immediately reduce their probability further, prepare to mitigate their impact when they occur, and recover from their effects as soon as possible. 7.High impact/low probability—Irrespective of the lower likelihood of these risks, their high-potential negative impact requires the same level of preparation, risk reduction, and risk mitigation as any high-impact imminent risk. This type of risk may be an excellent candidate for automated risk mitigation systems to overcome inevitable assumptions that events of this type are so rare that they won’t happen. Moderate-Impact Risks 6.Moderate impact/high probability—These risks are serious enough and happen frequently enough that they must be addressed in any risk management effort. They are top-of-the-mind risks, as well, because they occur so frequently. 5.Moderate impact/moderate probability—This level of risk represents a transition point in which investors who will not be seriously impacted or can recover quickly from moderate-impact risks may want to consider accepting these risks with little or no specific risk management initiatives. Otherwise, implementing risk management initiatives makes sense with these types of risk. 4.Moderate impact/low probability. Any investor who cannot easily tolerate a moderate-impact risk occurring should protect against this type of risk. Low-Impact Risks 3.Low impact/high probability—If the impact of these risks occurring will have no intermediate or longerterm effects on an investor, and they can recover from the impact of these risks quickly, then there is little reason to be concerned by them. There may, in fact, be ways to convert their frequent occurrence into opportunities. Annual Meeting Proceedings | 2012 165 166 Focus Sessions: Practice Management 2.Low impact/moderate probability—Because of their low impact, these risks can be accepted by all but conservative, risk-averse investors. The occurrence of these risks can also offer opportunities to more venturesome investors. 1.Low impact/low probability—These risks are the easiest to accept without any risk management initiatives because such initiatives provide little benefit for the effort. They can best be dealt with by just building their likelihood and impact into normal expectations. Once risk has been prioritized in this way, it becomes easy to determine which risks to avoid entirely (if possible), which risks to accept and manage, and which risks to accept outright with no risk management. Review Risk Reduction/Management Strategies Available Analyze the pros, cons, effectiveness, and costs of risk management strategies appropriate for managing each risk, that is, insurance, guarantees, diversification, hedging, and waiting to take advantage of market extremes of over- and undervaluation. Evaluate Your Risk/Reward Trade-offs Once our investment objectives are set, our risks identified and prioritized, and our risk management strategies determined, it’s time to perform one final, pre-decision check: • Do the potential rewards justify the risks? • Are our risk management plans adequate and in place? • Are we following the herd, doing what everyone else is doing, and letting our emotions override our logic, or is our logic managing our emotions? If you can answer those questions properly, you’re good to go to the next step. Make Your Decision to Act or Not to Act—and then Implement By this stage your decision should be straightforward and relatively easy. If for some reason it’s neither straightforward nor easy, or if you’re uncomfortable about your options in any way, it’s time to pause and give yourself more time or more information. Always keep in mind that one of the most basic rules of investing is to do only things you are totally comfortable doing. Life is just too short and capital too precious to make decisions that make you uncomfortable or keep you awake at night. So if you are uncomfortable for any reason, make an effort to identify what element Annual Meeting Proceedings | 2012 of your contemplated action is bothering you. Once you’ve identified that element, consider the implication of just discarding it. If those implications are small or nonexistent, how to proceed will be quite obvious. Should the implications be significant, it’s time to go back and consider other, different, or creative solutions. Either way, you’re ahead because you’ve learned one more alternative that won’t work for you in this situation. Ongoing, Continuous Risk Monitoring and Decision Making Use risk decision-making checklists every time you consider making a change to your plan, portfolio, or whatever, just to confirm that you’re not increasing your risk or falling into a decision-making trap inadvertently. Once you make your decision to proceed and put your plan into action, the new risk-monitoring phase begins. The purpose of the monitoring phase is to regularly check on your progress toward your planned goal and, if anything goes awry, to make the adjustments necessary to get back on course. In addition, it presents an opportunity to reconfirm that your circumstance and priorities are the same and that no developments or risks have popped up that may require a reevaluation of your plan. For this phase to be effective, you must set up a regular, ongoing, formal monitoring process where you can review what’s working, what’s not working, and what adjustments need to be made to your plan. It’s also important to be continuously on guard for new potential risk and threats, as well as for older, more comfortable risks that have evolved into new threats. It’s also critical to create an ongoing, risk-managed, decisionmaking checklist. Remember that the old adage “If you fail to plan, plan to fail” has proved that its value in risk management is just as critical as every other endeavor. Wrap-Up and Closing We’ve talked a lot about looking at risk in a new way and understanding and managing it more effectively. Now let’s compare the characteristics we identified at the beginning of this talk about the enormous opportunity and numerous benefits of integrating holistic, personalized risk management education and planning services to your suite of services. The Perfect Business-Building Initiative would offer: • A totally new and different service that has never been offered before ©Million Dollar Round Table How to Convert Client Anxiety About Risk into Business-Building Strategies • A way to meet an enormous and growing unmet worldwide need • A unique competitive advantage that helps you stand out above the competition and establishes you as thought leader and go-to resource • The ability to attract increased demand for your products and services in a new way, one that neutralizes your competition • Improved impact and effectiveness of your existing sales and marketing resources • Increasing the “stickiness” of existing business • A long and effectively limitless shelf life • Building client trust and confidence more easily and quickly • Another source of revenue and income that complements your existing business • A proven way to become a high-net-worth client business magnet • Gaining the respect and support of centers of influence ©Million Dollar Round Table • Independence from increased uncertainty and economic/ market fluctuations • A service that’s easy to implement into your practice • A service that’s applauded by compliance professionals and regulators • Attracting positive press, PR, attention, and buzz Adding comprehensive, holistic risk management planning and education services to your practice is an incredible opportunity to convert the accelerating pace of worldwide change and the growing anxieties, uncertainties, and concerns about the risk it generates into powerful businessbuilding forces and less stressful, happier clients. Hopefully, you now look at risk and risk management very differently, and you’re excited by the tremendous business-building opportunity in becoming known as a Risk-Wise advisor and helping to meet the enormous and growing worldwide need of people everywhere, and to better understand and manage the risks of our increasingly less certain world. Annual Meeting Proceedings | 2012 167
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