I am often asked why Voyant doesn’t have a standard risk tolerance questionnaire built into our base product. While we will implement a custom risk tolerance survey for our clients, I get a lot of puzzled looks when I respond by noting that risk surveys are a big reason for consumers’ disappointment in and distrust of the financial services industry.
After the recent market meltdown, consumers are realizing that these assessments are inaccurate, vague, provide very little value or insight – and often exist to only satisfy obligatory compliance and legal requirements, rather than to provide serious investment risk mitigation and protection. I would like to see the financial services industry reevaluate the risk tolerance survey and develop more valuable and reliable methods for determining a consumer’s need for investment risk. This should include a stronger value proposition that helps consumers achieve their personal goals, while incurring as little investment risk as possible.
I recently got an email from a major online brokerage suggesting I re-plan my retirement exactly the same way I had planned it before the recent meltdown. Fool me once, shame on you. Fool me twice, shame on me. If consumers have learned anything, it’s that the market does go down, and it can go down dramatically. Many consumers also realize that there is little their advisers can do to predict such downturns. If they could, then the recent losses would have not been nearly as large, especially for their clients closest to retirement with moderate or low risk profiles.
Consumers now know that the risk tolerance questionnaire is really just a sales gimmick for advisers to suggest the achievability of the highest potential returns based on a client’s survey responses, while protecting the adviser from legal action if the returns are not met. Most advisers and consumers do not understand the portfolio theory behind these surveys. Even those who develop the stochastic models can’t defend their accuracy, value or the existence of key mathematical components such as correlation coefficients. But they are still being pushed by the industry, using key disclaimers such as “previous performance is not indicative of future returns,” as a way to offload the risk to consenting consumers.
Asking how much risk a consumer is willing to take is less honest than asking them how much they are willing to lose by gambling. Most risk assessments include absurd questions that give little exposure to the underlying mathematical risks such as (real question taken from a risk questionnaire),
How do you feel when you suffer a financial loss?
a. I think I’m a bad person.
b. I feel guilty.
c. I view it as a personal failure.
d. I see it as an obstacle to be overcome.
e. I almost never suffer losses, because I don’t take risks that would lose me money.
I would like to see the risk assessment that includes the question:
How much of your portfolio’s value are you willing to lose in a single year?
e. 40% or more
Most people would likely answer a or b. However, these two answers would put them in very low risk categories, meaning that the market returns that could reasonably be illustrated would be very modest and the advisers perceived value might be reasonably low as well. I’d venture to guess that most people who are less than 10 years away from retirement and invested in moderate risk model portfolios that recently lost more than 40% never knew their tolerance survey would have had them answering e.
Without really digging into their clients’ personal needs, goals, deeper financial issues, or tolerance for market risk, how can an adviser recommend a reasonable model portfolio — no matter what the risk questionnaire says? Once a reasonable financial plan is built true guidance can be provided. Advisers need to educate consumers in the idea that increasing savings, reducing expenses and developing alternate strategies can do a lot to reduce the need to take investments risks. Advisers should focus less on how much risk the consumer is willing to tolerate and more on what the market can reasonably do to help them achieve their financial goals. In the long run this will increase customer satisfaction and assets under management. Without this change, consumers are going have less tolerance for the financial services industry.