Risk Questionnaires May Not Help Participants

Using risk tolerance questionnaires may not be the best way to help retirement plan participants choose suitable plan investments.

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 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,” Klein tells PLANSPONSOR.

Most questionnaires anchor their results on the stereotype of age, he notes. Then the questionnaires allow the other questions to nudge the person a bit to the conservative or aggressive sides, depending on their answers. Klein believes the results are not only subjective, but ambiguous, citing the description “moderately conservative” as particularly suspect.

“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.”

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 says it 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 52.9% of clients ages 20 to 29 invested outside their risk preference and 53% of clients older than age 70 invested outside their risk preference.

Riskalyze says each person’s Risk Number is unique. According to Mike McDaniel, chief investment officer at Riskalyze, the correct way to define individual risk preference is to determine how far his portfolio can fall within a fixed period of time before he capitulates and makes a poor investing decision.

“The net effect of using numbers instead of conjecture to discuss risk is happy and satisfied [investors], regardless of which way the market is swinging,” McDaniel says.

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. The firm’s report is available at https://www.riskalyze.com/clientexpectations.