Financial advisors have used risk tolerance questionnaires for years now, but they often leave too much room for interpretation. Investors are pigeon-holed into stereotypical categories based on a subjective risk questionnaire that nearly always misses the mark. This can leave investors with a portfolio that does not align with their investment goals and objectives – or their risk tolerance.
Here are three ways that typical risk tolerance questionnaires do no favors for investors.
1) You, as the investor, are stereotyped.
Typical risk questionnaires have a reputation for stereotyping investors purely based on age. For example, a 60-year-old investor may be pushed towards the “conservative” category, while a 30-year-old would be deemed “aggressive.” Questionnaires that make blanket assumptions based on the investor’s age often miss the mark when it comes to an individual’s time horizon for goals.
2) Your capacity to take risk is ignored.
“Risk capacity” refers to your ability to endure potential financial loss and still be able to achieve your goals.
While you might have the fortitude to stomach the swings in the market, if your portfolio is too aggressive you could be losing more money than you should be. On the flip side, some goals are aggressive but need an additional amount of risk in order to reasonably achieve your specific financial goals.
3) You’re asked to select the “most appropriate” answer.
These questionnaires are often in a multiple choice format where you select the “most appropriate” answer. For instance, what would be your answer for “Suppose the stock market performs unusually poorly over the next decade. What would you expect from this investment?”
- To lose money
- To make very little or nothing
- To eke out a little gain
- To make a modest gain
- To be little affected by what happens in the stock market
Exactly how much money would I be losing? What does “eke out a little gain” mean? These answers leave a tremendous amount of interpretation up to the investor.
There’s a Much Better Way for Investment Advisors to Understand Your Risk Tolerance
What if I told you there is a way to determine, in real dollar amounts — not vague terms like “very little” or “modest” — how much you are comfortable risking for potential gains?
The risk alignment questionnaire we use is built on a Nobel Prize-winning framework that uses cutting edge technology to identify an investor’s acceptable level of risk and reward. Using this tool, called Riskalyze, helps our investment clients define their financial goals and expectations, along with their risk tolerance. In turn, our investment advisors put together and manage an investment portfolio that accurately reflects our clients’ investment goals and expectations while taking into account risk tolerance.
Now What?
Do you have the appropriate amount of risk in your investment portfolio? Find out by taking a five-minute questionnaire that covers topics such as portfolio size and top financial goals, while showing real dollar amounts of how much you are willing to risk in your portfolio for potential gains.
When you complete the questionnaire, you will have a personalized Risk Number®, which will identify your acceptable level of risk and reward. It’s fast, free, and displays your number instantly.
If you would like more information about whether or not your Risk Number represents the actual amount of risk in your current portfolio, contact GGM Wealth Advisors or 410.685.9685.
