By now, most of you working with a financial advisor or robo-advisor have completed a standard risk tolerance questionnaire. You know the questions:
- How much of a percentage decline in your portfolio can you tolerate over the short term?
- How soon will you been needing the money you plan to invest?
- How old are you?
- Is your objective safety, income or growth?
But do these questions adequately assess your risk tolerance?
I don’t think so.
Here’s a simple example. Recently, a client answered that she would be comfortable with a 10% decline in the value of her portfolio. I then asked her if she could tolerate a $100,000 decline in portfolio value and she was far less enthusiastic. I pointed out that as her portfolio value was $1 million, $100,000 and 10% were for her the same thing. It was an eye-opener.
How do you actually behave as an investor?
At Queensbury Strategies, in addition to the typical risk tolerance and investor profile questions, we have started asking a few others, ones that provide a more accurate measure of our clients’ true risk tolerance. Such as:
- During the 2008/2009 financial crisis did you:
- Sell any investments that had declined in value?
- Hold onto your investments through the decline?
- Add to your investments through the decline?
- Contribute to retirement savings but leave the money in cash temporarily until the market settled down?
- How much of a decline could you handle in dollar terms before you would begin questioning your investment strategy?
- Quality investments designed to generate higher than GIC returns can experience temporary declines in value. What do you consider short-term?
- 1 month
- 6 months
- 1 year
- 2 years
During a recent conversation with consumer advocate and personal finance expert, Ellen Roseman, Ellen suggested another illuminating question that I plan to integrate:
4. How do you feel about insurance, e.g. property, life, product warranties, etc. (multiple answers are acceptable)?
- Insurance is a waste of money. I’ll take my chances.
- I have only what I have to by law or as required by my employer.
- I’ve purchased insurance but I’m not sure it’s enough to protect my biggest risks.
- A comprehensive insurance program helps me sleep at night.
- I purchase extended warranty plans.
- I purchase bank credit and mortgage insurance.
Actions speak louder than words
In other words?
Your real attitude towards risk is best measured by what you do, not what you think. Or what you think you think!
Get your risk tolerance right – it matters
The historical underperformance investors have experienced is largely due to a misalignment of their portfolio and their risk tolerance. That misalignment results in poor decision-making, particularly during times of market stress and market euphoria.* It even shows up in investment flows in mutual funds and ETFs.**
Getting your risk tolerance right when structuring your portfolio is Job One. As you were reading, did you ask yourself the questions I asked in this blog? Do you think that you and your investor would change your estimation of your risk tolerance, knowing these answers?
This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.