Why Risk-Profile Questionnaires Don’t Work

Ted

FYI: In constructing financial plans, I tell clients that the second most important decision they will make is to set the overall riskiness of their portfolio by deciding upon an asset allocation. I’ll disclose the most important decision at the end.

As a financial planner, I’ve been trained to administer what’s called a “risk profile questionnaire” to new clients to determine how much of their portfolio should be in more volatile asset classes like stocks. One of the best such questionnaires I’ve seen is this survey from Vanguard. It asks questions about how clients feel about risk and when they will need their money, with the answers supposedly determining how much risk to take.
Regards,
Ted
https://www.advisorperspectives.com/articles/2019/08/26/why-risk-profile-questionnaires-dont-work

Old_Skeet

Years back when I was in the accumulation phase of investing I rolled with equity allocations, at times, upwards towards the 60% to 70% range along with holding about 10% in cash so when stock market pullbacks came I had some cash that I could put to work to take advantage of the pullback. Then as the stock market recovered I'd trim my equity allocation booking some of the gains made during and after the recovery.

Interestingly, the Vanguard risk questionaire, contained in the article, suggested, for me, a portfolio of 40% bonds and 60% stocks. And, I'm retired.

Now being retired, for the past five years, here is how I now roll with a description of my all weather asset allocation detailed below.

Old_Skeet's All Weather Asset Allocation.

My all weather asset allocation of 20% cash, 40% income and 40% equity affords me everything necessary to meet my needs now being in the distribution phase of investing. The benefit of this asset allocation is that it provides sufficient income, maximizes diversification, minimizes volatility, and provides long-term returns.

The 20% held in cash area provides me ample cash should I need a cash draw over and above what my portfolio generates plus it can provide the capital necessary to fund a special investment position (spiff) should I choose to open one during a stock market pullback. In addition, cash helps stabelize a portfolio during stock market volatility. Example of investments held in this area are cash savings, money market mutual funds and CD's.

The 40% held in the income area provides me ample income generation to meet my income needs in retirement. It is a well diversified area that incorporates a good number of income generating type funds. Some examples of investments held in this area are ISFAX, LBNDX & PONAX.

The 40% held in the equity area provides me some dividend income along with some growth, that equities generally provide, that offsets the effects of inflation over time. Some examples of investments held in this area are NEWFX, SVAAX & SPECX

Generally, for my income distributions, I take no more than a sum equal to what one half of my five year average total return has been. In this way principal grows over time.

I'm thinking that all investors should write out their investment plan which should include how they plan to invest during stock market declines along with both short term and long term goals. Then monitor their results and make adjustments as warranted including rebalancing their portfolio form time to time to maintain their established asset allocation.

Derf

@Old_Skeet: I recently came across article that stated only 25 % of investor have a plan !
I guess I'm not one of them.
You stated, "In addition, cash helps stabelize a portfolio during stock market volatility. Example of investments held in this area are cash savings, money market mutual funds and CD's."
Yes ,but in a rising market it slows your returns down !!
I've seen that happen in my accounts.

Age, health, amount of assets, & income all play a large part in how one invests !

Have a good day, Derf

Old_Skeet

@Derf, Yes, cash becomes a drag during the updraft; but, helps during a downdraft. For me, the income area generates enough income to meet my needs. With this, I have dialed my risk level downward during the past five years, or so. Thinking ... Why take on more risk than is necessary? Perhaps, I should do as Ted did a while back and just cash out. But, then I'd owe the tax man a good sum of money in doing just that from the realized capital gains I'd have. And, besides I'd lose a good bit of income that my portfolio generates. So, I'll just roll along and take what the market gives me (good or bad) and clip my coupons.