S&A Financial Services, Inc. Blog
This content can also be found on Small Business Financial Podcast - episode #6
This is one of those aspects of my industry that’s a necessary evil. As financial advisors, we’re mandated to have a version of these Risk Tolerance Questionnaire on file, but I do believe it’s a poor substitute for good financial planning.
From an adviser’s perspective, I view these Risk Tolerance Questionnaire's as some sort of CYA insurance policy to help protect the advisor if potential litigation comes against the advisor down the road.
I think the typical process of onboarding a client is somewhat backwards….most of time, not always, of course. We’re taught, as advisors, to have an onboarding client fill out this arbitrary Risk Tolerance Questionnaire the first or second meeting. However, this is like saying, from clients perspective, “this is what I think I’d like” in terms of risk / reward ratio. Then the advisor comes back and says, “well, this looks good, we’ll go ahead and put you in this pre-constructed model here." Pay no mind that 100 other folks in the firm have the exact same model....right. I’ve never got on the pre-constructed portfolio model structure.
I can easily tell you why advisors have these pre-constructed models, and I’m sure you can figure it out a well, but it makes their life A LOT easier. For example, at my firm, all of my clients have personalized portfolios. Yes, it takes me longer to do “things,” but after I get to know the client, we find that each person has different expectations and we invest their portfolios accordingly.
In my opinion, the traditional thinking, or process, of filling out the Risk Tolerance Questionnaire before you get to know the client is backward thinking. I like to reverse engineer into that Risk Tolerance Questionnaire. Get to know the client and educate them regarding risk associated with stocks / bonds.
Piggybacking off the “reverse engineering” phrase, reason why I say that is that I like to do some sort of financial planning first. Reason being, is that we’ll find out how aggressive the client NEEDS to be. For example, after our financial plan, we find that this hypothetical client hasn’t saved enough and not really on the ideal track towards a “safe” retirement. We find that this client NEEDS to make around 8% per year for our plan to work successfully. Therefore, this client needs to take a little more risk....at least we have that conversation.
Conversely, after finishing our financial plan, we find that a client only NEEDS to make 3% per year for their plan to financial succeed. Well, guess what, we're going to have the conversation around removing unnecessary risk from portfolio. Conversation is a little more nuanced, but you get the idea.
Again, I’ll reiterate. The Risk Tolerance Questionnaire just gives the advisor an excuse to be lazy and plug you into the pre-constructed model and not go through the process of educating you on different aspects of the markets.If you run across this situation…I’d advise that you take your business elsewhere….again, just my opinion here.
Let me give you a simple example of what I’m talking about. Take a 60 /40 stock / bond portfolio. That 60% allocated towards stocks could be invested totally different when it comes to risk from one portfolio to the next. Extreme example would be if that 60% for one portfolio was all in tech / growth and a different portfolio had 60% in value / dividend producing stocks.
Yes, both have 60% stocks, but wouldn’t we agree there’s more risk associated with one of those portfolios over the other? This is where the Risk Tolerance Questionnaire just doesn’t work.
Also, think about this…. Risk Tolerance Questionnaire's can certainly be swayed given what’s going on the world, right? For most folks out there, think about how they felt during the Pandemic. You think the Risk Tolerance Questionnaire would have been swayed a little more conservatively during that time period….than say….middle of 2021 when the market was on fire?
Again, not everyone, but for most people…it can be a glimpse into moment of time that you filled out that Risk Tolerance Questionnaire in the context as what’s going on around you.
In my opinion, I can’t stress this enough, having real life conversations with people will do SOO much more than a 12 question document.
Transitioning just a little bit….I’d like to discuss the topic of risk and how I believe it’s misunderstood to many investors. I think, again, for a lot of folks out there, a low risk tolerance is a symptom of lack of education. I believe the more educated about the market, this goes for the bond market as well, the more exposure you’ll have to the stock market.
I tell some clients, not all of them, that we like to use the “F” word here at S&A Financial Services. Of course, you can imagine the initial looks I get. But I tell them "F" stands for Fearless. You must be fearless when exposing your portfolio to the stock market.
So, there’s my thoughts around the antiquated, but unfortunately necessary Risk Tolerance Questionnaire . I’ll leave you with this….as your interviewing fee-only financial advisors and they want you to fill out one of these Risk Tolerance Questionnaire before they get get to know you, I’d start questioning the process. Because the next thing you know is that they’re going to throw you in one of those pre-constructed portfolios along w/ 100 other clients.