Risk Tolerance Questionnaires

The only way to get people to be longer term investors is to get them to react well in the short term.” – Aaron Klein, CEO of Riskalyze.

Advisors often advocate staying fully invested during periods of market volatility.  This is mostly sound advice, however, if investors are ready to jump ship at the first sign of adversity they are probably invested incorrectly in the first place.  In our opinion, traditional risk tolerance questionnaires used for profiling risk have generally failed to evolve to reflect current behavioral biases and attitudes.

When profiling the risk tolerance of investment clients, advisors have historically followed an association of older investors are conservative and younger investors are aggressive.  The guideline is a mental shortcut that is sometimes true, but lower incomes, compressed investment returns, and boom/bust market cycles have changed risk appetites for younger investors (and some older investors too).  For example, I started managing conservative fixed income portfolios during the height of the financial crisis in 2008.  Witnessing “safe haven” assets lose 5-10% shaped the way I view the world.  Older portfolio managers experienced the booming 80’s and 90’s where equity markets were appreciating 15%+ per year.  The extraordinary investment returns influenced their view of world to be more optimistic (bullish) investors. 

The other challenge when building risk efficient portfolios is translating the results for investors.  Most people understand the basic premise of risk, however, it’s tough to explain the impact in digestible terms.  Does hearing your advisor say, “your current portfolio has a standard deviation of 11.5%,” resonate with you? Probably not.

We took into consideration the unique challenges investors faced and wanted a “risk first” approach as we built our investment platform at Pure Portfolios.  We decided to partner with Riskalyzewhich modeled their platform based upon decades’ worth of behavioral economic work.  This includes (but not limited to) the academic framework Prospect Theory that won the Nobel Prize for Economics in 2002.

Humans look at risk and reward in the context of their own personal financial position.  We all look at risk differently, based on our varying life experiences and financial position.  Building portfolios based upon mental shortcuts is a recipe for disaster. Don’t just take our word for it…check out theRiskalyze survey and build a more risk efficient portfolio.

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