Question: I was making an investment with my guy and he got me to fill out something called a risk tolerance questionnaire. It asked me questions like how much was I willing to have my account go down. At first I put zero, but he said I couldn’t say that, so I put something else, I don’t remember. Why do you guys use those questionnaires? They seem silly to me.
Answer: The “right” answer is to say that we use risk tolerance questionnaires to protect you (the investor) from putting your money in anything that has more risk than you may be willing to tolerate.
The answer no one will admit in public is that we use those kinds of questionnaires as much to protect ourselves as we do you.
If the market goes significantly down after an investment firm has put your money in the market, you could come back and say, “Hey, I didn’t sign up for a 25% loss!” But if the firm had you complete an investment risk tolerance questionnaire, which said you understood the market could go up or down 25% in short order, you wouldn’t have a very good argument that you didn’t know what you were getting yourself into.
I am not saying that risk tolerance questionnaires are not useful tools. They are. They just have limits you would be wise to appreciate.
For one, who really knows their risk tolerance? You may have never gone through a bear market (in which the average price of the securities in that market declines 20% or more).
And even if you have gone through a bear market, you haven’t gone through all of them. It’s easy to look years into the rear view mirror and talk about what you should or should not have done during the last bear market. The reality is that each bear is different and the circumstances leading up to and surrounding it are all uniquely apocalyptic sounding at the time.
Also, your reaction to a bear market changes with the size of your assets. I’ve talked to any number of people who had a few though dollars in their 401K and the boast of “not even paying attention” to the market busts of 2002 or 2008.
That same person will likely have a significantly different reaction when he’s got several hundred thousand (or even a million) dollars at risk. The blasé attitude is nowhere to be found; now it’s all doom, misery and gloom during bear markets.
Finally, age affects your risk tolerance (I believe) more than anything else. I’ve worked with clients long enough to see more than a few make the transition from daredevil risk-taker to cowardly lion care-taker. Why would you think age would affect your tolerance for risk any less than age affects your tolerance for lots of other things?
So, I agree it can sometimes feel forced (or silly as you say) to attempt to measure something as deep-seated and mysterious as your tolerance for risk (during a traumatic event no less) with a questionnaire. It feels like you’re trying to learn how to dance by reading text book. You actually have to practice in real life.
That’s why working with an advisor you can trust is so important. There will likely be times when you have to “borrow” his or her faith in the markets, because yours is running on empty.
So a questionnaire is a great place to begin. I’d suggest a good eye to eye conversation about the reality of bear markets and how you (and your advisor) will react is an even better step to take.
Can investment risk tolerance questionnaires (and hopefully the conversations they spawn) be a bit awkward and forced? Yes.
But silly? No way.
Byron R. Moore, CFP® is managing director / planning group of Argent Advisors, Inc. Email him at firstname.lastname@example.org. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5858. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc. No forecasts can be guaranteed. Argent Advisors, Inc. does not offer tax, insurance or legal advice. The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.