Is It Time to Dust Off Your Risk Tolerance Questionnaire?
During first meetings and conversations with financial advisors, investors generally discuss 3 key things: their goals, their time horizon to work toward those goals, and their tolerance for risk. A formal risk tolerance questionnaire may have been presented, seeking to gauge your feelings should the markets drop 10%, 20% and so on.
Like many things, when markets are steadily rising, many investors believe they can withstand significant levels of risk because the risk is not tangible. When the investor opens their statement, they generally only see the value going up. This has been the case by and large for quite a few years now, with some slight downturns here and there, but overall things for many people have been good.
Throw a little fall volatility into the mix, and how are you feeling? Is that risk tolerance questionnaire a truly an accurate reflection of your feelings now that risk is a bit more palpable? The thing is, risk tolerance can be something that changes - it is not “set in stone”. It can be more dynamic, with investors feeling differently in different market scenarios.
That’s why it is so important to let your advisor know how you are feeling about risk when risks present themselves. Perhaps it’s time to pull out your copy of your risk tolerance questionnaire and review it. If it is one where there is a risk “score” applied, see how close you come to that initial score. If close/the same, no changes might be needed. If you see some divergence, perhaps a review is in order. Please note, however, that risk tolerance is not the only factor which influences the creation of a portfolio and its ongoing management.
What type of questions are asked on a risk tolerance questionnaire or in a risk conversation? These may vary a bit by company or advisor who is asking, but in general we might expect to see some similarities in the overall information gathering:
- Current expenses (fixed budget)
- Future expenses (goals)
- “Must have” goals (such as retirement) versus “nice to have goals” (such as a vacation home)
- Investable assets
- What percentage do the investable assets represent in terms of overall assets (in short, is there other money, property, etc.)
- How liquid are the other assets
- Short term attitudes about risk (reactionary behaviors toward market news)
- Long term attitudes about risk (willingness to undertake some risk)
- Personal: do you suffer from generalized anxiety? Is there a reason why your ability to take a risk is impacted (for example, you grew up in Great Depression). Is there a special situation such as providing for a child with disabilities for life? This is where having a trust relationship with your advisor where you can communicate these important pieces of information is key, as they might shape your overall attitudes toward investing.
- What is the overall purpose of the money in your life? (Is it leaving a legacy or to be utilized now?).
Having a confidential conversation with your advisor is important. Hiding information whereby the advisor makes recommendations based solely on the known assumptions may be damaging overall. Long-term attitudes about risk are likely far more important than short term behavioral “knee jerk reactions” to market events, as you may miss out on gains by taking “extreme” risk-aversion actions like pulling all money out of the markets. It’s important to provide all aspects of information so that each can be considered in an overall investment approach.
Risk tolerance may be malleable, fluid, flexible, dynamic, changing. Help your advisor help you, and communicate your thoughts about risk. A conversation may help put things in perspective.
I am pleased to help you, your family members, friends and colleagues and offer a complimentary first consultation.
The opinions are those of the author. Seek assistance from a qualified professional before taking any action in regard to your finances.
Todd A. Slingerland, CFP®
6 Tower Place Albany, 12203 (518) 867-4000 x105 firstname.lastname@example.org