The Trouble with Risk Questionnaires

The problem, says Aaron Klein, chief executive of Riskaylze, is the very subjective nature of the questions and the questioner.  “Psychological and qualitative questionnaires are subjective,” Klein tells PLANADVISER,  “because someone is always tasked to weight the various answers into some kind of score or result, and that is inherently a judgment call on the part of the designer.”

In “Using Risk to Manage Client Expectations: How to Gain ROI by Talking about Risk Instead of Returns,” Riskalyze examines the flaws of age-based risk stereotyping and discusses how properly approached conversations about risk can substantially improve quality of life for both advisers and clients.  

Access to digital and mobile technology offers clients almost unlimited information in real time as never before, the paper notes. Advisers as a result are experiencing ever-increasing challenges in managing client expectations and communication about investment performance.  When the risk discussion focuses on returns or ambiguous risk tolerance cohorts such as “conservative” or “aggressive,” the resulting communication gap can be harmful to firm efficiency and the adviser/client relationship, Riskalyze contends.  

Most questionnaires anchor their results on the stereotype of age, Klein says. Then the questionnaires allow the other questions to nudge the person a bit to the conservative or aggressive sides, depending on their answers. “The results of many of these questionnaires are ambiguous and subjective,” he believes, citing the description “moderately conservative” as particularly suspect.

Age-based stereotyping in risk discussions can lead to serious misalignment, with anywhere from 26% to 53% of clients falling outside their stereotypical age-based risk tolerance buckets. The misalignment is demonstrated across all age brackets, with 53% of clients over age 70 invested outside their risk preference.

“Building a portfolio on this basis is the equivalent of your architect telling your contractor to build a moderately conservative hallway leading into a moderately aggressive bedroom and expecting things to work out,” Klein says. “There’s a reason we adopted feet and inches in construction, and we need to make the jump to quantitative benchmarks in investing as well.”

Riskalyze recommends that advisers concentrate on educating clients about the uniqueness of their own quantitative Risk Number. According to Mike McDaniel, chief investment officer at Riskalyze, the correct way to define individual risk preference is to determine how far their portfolio can fall within a fixed period of time before they capitulate and make a poor investing decision.

“The net effect of using numbers instead of conjecture to discuss risk is happy and satisfied clients, regardless of which way the market is swinging,” McDaniel says.” This in turn leads to greater efficiency, productivity and client relationships.”

Riskalyze, in Auburn, California, works with registered investment advisers (RIAs), hybrid advisers, broker/dealers, custodians, clearing firms and asset managers to align the world’s investments with investor risk preference.

“Using Risk to Manage Client Expectations: How to Gain ROI by Talking About Risk Instead of Returns” is available for download from Riskalyze’s website.