You must be honest about your objectives, values, family dynamics, investing style and preferences if you wish to build and preserve a suitable investment portfolio.
You also have to know your own attitude to risk.
Tools for financial planning or advice from a financial consultant will seek to better understand your degree of risk tolerance. You might be in more risk, higher-reward investment methods if you say you can tolerate significant drops to your account without panicking.
You will be encouraged to be cautious with your money and take action to limit your portfolio risk if you dislike losing money and are afraid of riding the market roller coaster; even if odds are strong that your portfolio will recover from the loss.
The idea of risk is somewhat illusive. Investors find it difficult to predict their reaction should and when they lose a sizable portion of their savings.
Software available to some financial advisers examines your comfort level with investing risk. These tools seek to enable advisers to make financial decisions that fit your tastes by measuring risk tolerance—that is, by, say, assigning a score based on your responses to a questionnaire.
These tools have some advisers glowing. Some people seldom pay any attention to them. “For many years, I used risk-tolerance questionnaires when I was with other firms,” Los Angeles-based certified financial planner Bill Nugent remarked. “They created problems and a false sense of knowledge since they were often so misleading and erroneous.”
These days, Nugent uses exploratory talks to determine the risk level of a potential client. He can mention a specific investment, stress the hazards, and ask the client’s view should they decide to proceed.
“You would spend a lot of time guiding the client through these abstract questions on risk-tolerance questionnaires,” he said. Based on their preconceptions about how they planned to invest the client’s money, some advisers would gently encourage the customer to provide the “right” response.
Nugent also discovered that a client’s future reaction should they lose a bundle had little to do with what they said in their first appointment with their adviser.
“Ask someone on a diet if they can resist a nice big piece of cake at a party; they’ll say, ‘Sure,'” he added. “Fast forward: someone brings them that piece of cake at a party. Resisting in the moment is even more difficult. Inquiring about one’s hypothetical future actions and presuming that future forecasts would come true is not a dependable system.”
Although Nugent agrees that tools for risk-assessment can provide a starting point for talking about investments, he argues that keeping constant contact with clients regarding their money is indispensible.
“Build a client’s degree of trust with you as their adviser,” he advised. “You do that by being in regular contact with them, preparing them for ups and downs” and teaching them how their portfolio might perform under a range of circumstances.
Other counselors create their own methods of assessing a client’s risk. They customize risk assessment and use it into their interaction with new clients instead of depending on off-the-shevel software or generic surveys.
Certified financial planner Filip Telibasa of Sarasota, Florida asks new clients to complete seven multiple-choice questions. “It’s purposely short and includes both qualitative, emotional questions and quantitative, numbers-oriented questions,” he said. “A starting point for a conversation to dig deeper and confirm their true risk tolerance.”
One of the inquiries asks, for instance, how a client defines “long term.” (“In making a long-term investment, I intend to keep the money invested for…”)
“If they say ‘one to two years,’ that indicates they have the lowest risk tolerance,” Telibasa said. “They have more risk tolerance if they choose’more than 10 years.'”
Investors who once boldly saw themselves as aggressive may rethink that bravado in times of market instability. Advisers expect such changes of heart.
“People’s risk tolerance is a function of what the market is doing in the last few weeks or months,” Boston-based adviser Russell Hackmann said. “If the market halves, I don’t know too many investors who can shrug that off.”
