By accurately predicting a client’s risk tolerance -- and, therefore, their investment behavior – we can design a portfolio strategy with more confidence that our client will stick with it over the course of the plan.
To begin, we hold conversations with clients. We also know that a variety of questionnaires available to help in this assessment.
The problem, however, is that all too many such questionnaires seem designed to actually measure risk capacity, not risk tolerance. Many of the commonly used “investor risk” questionnaires are actually asset allocation calculators mislabeled as risk tolerance tests.
To be a good tool for measuring the latter, the questionnaire needs to adhere to sound psychometric principles. An individual’s risk tolerance is largely a psychological matter.
At Thorley Wealth Management, we use a questionnaire developed and tested in Australia with the assistance of the University of New South Wales and now maintained under the auspices of the London School of Economics. According to FinaMetrica, it is used in 20 countries, has been taken by more than a million people, and has gained international recognition as one of the world’s best.
We cannot over emphasize how important it is to align risk tolerance and risk capacity. If someone’s risk tolerance is not sufficient to support the risk capacity needed to reach one’s goals, then a reassessment of the goals may be necessary.
As a financial planner, the overriding objective is to design a plan that will be a win-win, helping the client reach goals and meet expectations while in a risk tolerance comfort zone.