Risk Questionnaires: How they work?

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nbui
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Risk Questionnaires: How they work?

Post by nbui »

How do companies take risk questionnaires and translate them to asset allocations? Are they all using the same equation/scoring?
lack_ey
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Re: Risk Questionnaires: How they work?

Post by lack_ey »

How and why would they be the same?

These kinds of surveys are a bunch of crap anyway, with answers varying widely depending on mood, framing, recent events (and in the investing world, "recent" means last several years, i.e. a long time in human terms), etc. I doubt they're all that well capturing anybody's risk tolerance.

Then the mapping of scores to allocations is arguably suspect too.
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Re: Risk Questionnaires: How they work?

Post by dbr »

It is still an interesting question how a company arrives at a recommended asset allocation from the answers to one of those questionnaires. The answer might document how useless the result is.
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Re: Risk Questionnaires: How they work?

Post by livesoft »

One way to do it might be to take a large group of investors and survey them. The investors would have to already have asset allocations that they were comfortable with along with known goals (retirement, college, legacy, …) and known time frames (next year, 5 years, 10 years, …). Then the survey could correlate the answers with the already known practices of these folks.

Then when the survey was given to someone out-of-sample (i.e. a new client), the analysis would be something like, "Your answers are closest to a person who has a 70/30 asset allocation." Or maybe something like 35% of folks with similar answers were 70/30, 30% were 60/40, 10% were 80/20, and rest were split with less than 5% in any other range.
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Re: Risk Questionnaires: How they work?

Post by pkcrafter »

I agree with Lack_ey and dbr. Risk tolerance is very individualistic--problem 1. Risk tolerance questionnaire results will vary from one test to another for the same individual--problem 2. A new investor won't know how to accurately answer the questions--problem 3.

Look at the following question:
If you unexpectedly received $20,000 to invest, what would you do?

Deposit it in a bank account, money market account, or an insured CD
Invest it in safe high quality bonds or bond mutual funds
Invest it in stocks or stock mutual funds
What I would do with this money--split between bonds and stocks--isn't even an option. :confused

Let's try something, nbui.

Have you been through a market crash?
What do you believe your tolerance for losses is?
What would you think would be a good asset allocation for you (% stocks, % bonds and cash)?

Paul
Last edited by pkcrafter on Sat Mar 28, 2015 12:41 pm, edited 1 time in total.
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Bustoff
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Re: Risk Questionnaires: How they work?

Post by Bustoff »

You can rest assured there is an element of marketing built into those questionnaires depending on the institution.
None that I've ever seen ask the question ... How much are you willing to lose tomorrow ?
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Re: Risk Questionnaires: How they work?

Post by sk.dolcevita »

Bustoff wrote:You can rest assured there is an element of marketing built into those questionnaires depending on the institution.
None that I've ever seen ask the question ... How much are you willing to lose tomorrow ?
I think these risk questionnaires provide legal shield for the providers by showing "good faith" effort to determine suitability of recommended course of action. They don't need to be right; they just need to show that tried to. Frankly, I think it would suffice for most investors to be put into three buckets - conservative, moderate, and aggressive, with moderate being the largest bucket.
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Re: Risk Questionnaires: How they work?

Post by mickeyd »

nbui wrote:How do companies take risk questionnaires and translate them to asset allocations? Are they all using the same equation/scoring?
The way that I see it is that a company's risk questionnaire in not much more than a marketing piece that moves you along to making a decision to "sign on the line which is dotted" and mail it in with a check.
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Re: Risk Questionnaires: How they work?

Post by sawhorse »

pkcrafter wrote:I agree with Lack_ey and dbr. Risk tolerance is very individualistic--problem 1. Risk tolerance questionnaire results will vary from one test to another for the same individual--problem 2. A new investor won't know how to accurately answer the questions--problem 3.

Paul
I'll add a couple more.

How you think you'll react may not be how you'll actually react--problem 4.

How you reacted in the past may not be how you'll react in the future--problem 5.
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Re: Risk Questionnaires: How they work?

Post by nbui »

lack_ey wrote:How and why would they be the same?
I did not believe they would be the same but I wondered if there was some universal formula from academia that all these surveys are based on.
pkcrafter wrote: Let's try something, nbui.

Have you been through a market crash?
What do you believe your tolerance for losses is?
What would you think would be a good asset allocation for you (% stocks, % bonds and cash)?

Paul
1. No. Was not-of-investing-age in '08.
2. As a percent: 25% of invested assets, retirement and taxable accounts.
3. 85/10/5 stock/bonds/REIT fund.
mickeyd wrote: The way that I see it is that a company's risk questionnaire in not much more than a marketing piece that moves you along to making a decision to "sign on the line which is dotted" and mail it in with a check.
This question is motivated by the rise of roboadvisors. All of them claim to tailor the management of assets to an individual's goals and risk tolerances. So when I go to their sites, I believe your statement is very true because they invite you take their survey and the final page is "ok, sign up!"
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timboktoo
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Re: Risk Questionnaires: How they work?

Post by timboktoo »

I actually like those questionnaires. I've linked multiple people to Vanguard's questionnaire, as well as their Portfolio Allocation Models page, to help them try to figure out an asset allocation they're comfortable with. I refer to them myself sometimes in order to remind myself about the benefits of having a substantial allocation to bonds.

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Re: Risk Questionnaires: How they work?

Post by anonyvestor »

The value of these questionnaires is likely to create a database which is of value to the surveyor, rather than to the survey participant.

If one invests with them, they can follow your purchase and sales, and correlate with the survey - for their own marketing purposes.

Or maybe it is as simple as clickbait.
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Re: Risk Questionnaires: How they work?

Post by 555 »

How about this for a Risk Questionnaire?

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Re: Risk Questionnaires: How they work?

Post by nisiprius »

It's an interesting question what's behind these questionnaires and I'd love to know the answer.

In a vague sort of way, I know that brokerages are required to "know their clients." I also know that brokers are required to sell clients only investments that are "suitable" for them. If a client is sold an investment that is not "suitable," the organization that enforces the requirement and disciplines the broker is FINRA, a rather mysterious entity; Wikipedia says that
Financial Industry Regulatory Authority, Inc. (FINRA) is a private corporation that acts as a self-regulatory organization (SRO). FINRA is the successor to the National Association of Securities Dealers, Inc. (NASD) and the member regulation, enforcement and arbitration operations of the New York Stock Exchange.
It's my belief, but it's only belief, that there is no science whatsoever behind the risk questionnaires at all. It's probably just a codification of conventional wisdom.

And it's my belief that the purpose of the risk questionnaires is not to serve the client so much as it is to protect the brokerage, by putting something objective on record regarding the client's self-reported risk tolerance. That is to say,, having answered "d" to a questionnaire that asks
From September 2008 through November 2008, stocks lost over 31%. If I owned a stock investment that lost about 31% in 3 months, I would: (If you owned stocks during this period, select the answer that corresponds to your actual behavior.)

a) Sell all of the remaining investment.
b) Sell a portion of the remaining investment.
c) Hold onto the investment and sell nothing.
d) Buy more of the investment.
With "d" on record, after a stock market correction, it would be hard to complain to FINRA and complain that an ordinary target-date retirement mutual fund was unsuitable for you.
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Re: Risk Questionnaires: How they work?

Post by Noobvestor »

1. No. Was not-of-investing-age in '08.
2. As a percent: 25% of invested assets, retirement and taxable accounts.
3. 85/10/5 stock/bonds/REIT fund.
#3 contradicts #2. If you can only stomach 25% losses, you should be no more than 50% in stocks and REITs, because they could drop 50%+ in a downturn. Could argue there is some nuance here (e.g. bonds should go up when stocks are down, etc...) but 90/10 stocks (REITS are in the same category)/bonds doesn't seem suitable for your risk tolerance.
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Re: Risk Questionnaires: How they work?

Post by pkcrafter »

nbui wrote:
lack_ey wrote:How and why would they be the same?
I did not believe they would be the same but I wondered if there was some universal formula from academia that all these surveys are based on.
pkcrafter wrote: Let's try something, nbui.

Have you been through a market crash?
What do you believe your tolerance for losses is?
What would you think would be a good asset allocation for you (% stocks, % bonds and cash)?

Paul
1. No. Was not-of-investing-age in '08.
2. As a percent: 25% of invested assets, retirement and taxable accounts.
3. 85/10/5 stock/bonds/REIT fund.
mickeyd wrote: The way that I see it is that a company's risk questionnaire in not much more than a marketing piece that moves you along to making a decision to "sign on the line which is dotted" and mail it in with a check.
This question is motivated by the rise of roboadvisors. All of them claim to tailor the management of assets to an individual's goals and risk tolerances. So when I go to their sites, I believe your statement is very true because they invite you take their survey and the final page is "ok, sign up!"
nbui, first thing: REITS are stocks, so your actual asset allocation (AA) is 90/10. On top of that, REITS are quite volatile, so you could be looking at losses between 45 and 50%.

The 50% loss number is based on several market crashes that have occurred since 1929. In the '29 crash losses were ~80%. The NASDAQ lost ~70% in the 2000 crash, so there is no guarantee that losses will stop at 50% in the future, but it's a reasonable guideline.

Here's a couple of charts--

Equity Exposure……............ Max loss
20%…………………………………5%
30%……………………………….10%
40%……………………………….15%
50%……………………………….20%
60%……………………………….25%
70%……………………………….30%
80%……………………………… 35%
90%……………………………… 40%
100%……………………… …… 50%

Loss (%)… Reqired Gain to get back
5%………….. … 5.2%
10%…………….. 11%
15%…………….. 18%
20%…………….. 25%
25%…………….. 33%
30%…………….. 43%
35%…………….. 54%
40%…………….. 67%
45%…………….. 82%
50%…………… 100%

Final note: it is very difficult to know your real tolerance before actually being tested in a market crash. The 50% loss doesn't occur all in a single year, it usually drags on over two or three years, making it very difficult to not only stay in, but also invest new money. So, my suggestion for an AA would be 50-60% stock until you've been through the perils of a hard drawdown.

A market crash reduces the value of the equity shares you own, but does not reduce the number of shares you own, so you've got to hold and wait for the value to rise. Selling would actually cut in half the number of shares you own, so when a recovery occurs, you will come up very short and lose the rebound opportunity for good. This is why selling is ultimately very damaging to long term accumulation.

Paul
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nedsaid
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Re: Risk Questionnaires: How they work?

Post by nedsaid »

lack_ey wrote:How and why would they be the same?

These kinds of surveys are a bunch of crap anyway, with answers varying widely depending on mood, framing, recent events (and in the investing world, "recent" means last several years, i.e. a long time in human terms), etc. I doubt they're all that well capturing anybody's risk tolerance.

Then the mapping of scores to allocations is arguably suspect too.
This pretty much mirrors my thoughts on risk questionnaires. I think they have limited usefulness at best. Were I a financial advisor, I would base client asset allocation decisions based on a pretty extensive interview, then you would have to see how the client behaves with actual investments. Some people talk a real good game but get nervous at the first hint of volatility.
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Re: Risk Questionnaires: How they work?

Post by Fallible »

nbui wrote:How do companies take risk questionnaires and translate them to asset allocations? Are they all using the same equation/scoring?
It would, of course, be impossible to know exactly how "all" or even most companies use these questionnaires to determine AA, but as the poster dbr said earlier here, "The answer might document how useless the result is."

I do think Vanguard's questionnaire seems meaningful and I like the information it provides investors up front: https://personal.vanguard.com/us/FundsInvQuestionnaire

Still, as the pro adviser Rick Ferri has said, "Risk tolerance questionnaires can be useful, but they have to be taken in the context of a bigger picture. ... It’s best to take a step back and reflect upon the goal first and how to achieve it. Only then will a risk tolerance questionnaire have some usefulness in your life."

Here's all of Rick's blog: http://www.rickferri.com/blog/strategy/ ... ionnaires/
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Re: Risk Questionnaires: How they work?

Post by ourbrooks »

livesoft wrote:One way to do it might be to take a large group of investors and survey them. The investors would have to already have asset allocations that they were comfortable with along with known goals (retirement, college, legacy, …) and known time frames (next year, 5 years, 10 years, …). Then the survey could correlate the answers with the already known practices of these folks.

Then when the survey was given to someone out-of-sample (i.e. a new client), the analysis would be something like, "Your answers are closest to a person who has a 70/30 asset allocation." Or maybe something like 35% of folks with similar answers were 70/30, 30% were 60/40, 10% were 80/20, and rest were split with less than 5% in any other range.
Turns out, someone has already done something close to that: http://citeseerx.ist.psu.edu/viewdoc/do ... 1&type=pdf
Alas, what I don't think has been screened for is how long people held their allocations. If they held the allocation long enough to experience some market downturns, then the methodology would probably be workable: "You're most like people who held a 70/30 allocation over the past 10 years." Odds are that if you did the same asset allocation, you'd be happy with it.
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Re: Risk Questionnaires: How they work?

Post by digarei »

Ok, I'll add, along with Timboktoo, a contrarian note to this deluge of skepticism. I do not know the mechanics of how these questionnaires are devised but I can tell you that as a new investor, I learned something about myself the first time I completed one: I realized that I had a greater need to take risk than I'd assumed. That I was willing to risk losing money in purchasing additional shares of stock when the market had fallen precipitously. This was valuable knowledge through the 2008-2009 financial crisis and I've noticed that my answers to such quizzes have not changed substantially in the twelve years since responding to the first one.
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Re: Risk Questionnaires: How they work?

Post by Uncle Pennybags »

nisiprius wrote:And it's my belief that the purpose of the risk questionnaires is not to serve the client so much as it is to protect the brokerage, by putting something objective on record regarding the client's self-reported risk tolerance.
IMHO one does not need a broker, especially if they don't know what they are doing. Brokers salivate when an unknowing mark walks in the door. Just read some of the posts on this forum and it is clear brokers are not fiduciaries.

That said I have taken many on line risk surveys and they all give me about the same asset allocation. The only difference is the funds they suggest, all in house of course. The betterments who don't offer their own funds give me the same asset allocation. Surprise most of the suggested funds are Vanguard but they suggest holding too many funds to justify letting them handle the portfolio.

Investors must know themselves and invest accordingly.
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Re: Risk Questionnaires: How they work?

Post by nisiprius »

lack_ey wrote:These kinds of surveys are a bunch of crap anyway, with answers varying widely depending on mood, framing, recent events (and in the investing world, "recent" means last several years, i.e. a long time in human terms), etc. I doubt they're all that well capturing anybody's risk tolerance.....
I agree. And "framing" is particularly interesting, because every risk tolerance questionnaire I've seen seemed to frame the questions in a way designed to encourage taking risk. The interesting one is this. During 2008-2009, stocks dropped a bit more than 50%, and almost everyone I know experienced it that way--about a 50% loss. (The joke: "My 401(k) is now a 201(k)," for example). Yet, even though a 50% drop occurred well within living memory :) , every risk questionnaire I've seen frames the questions in such a way as to avoid asking about a 50% loss, but some other, smaller number.

The maximum loss Vanguard asks you to consider is 36.3%... and notice how every salmon-colored (not red, of course, that would be too scary) is nicely overbalanced by a taller navy-blue bar.

Image

Wealthfront minimizes the impact by restricting the time period to a month, and talking about a "10%" fall. But once again, the market dropped over 20% in one month in September 2008, so why talk about half that? And at least some of us can remember the market dropping over 20% in one day in 1987. You have to live through the real drops that actually occur--why assess risk tolerance by using hypothetical drops that are smaller?

Image
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Re: Risk Questionnaires: How they work?

Post by livesoft »

ourbrooks wrote:
livesoft wrote:One way to do it might be to take a large group of investors and survey them. […]
Turns out, someone has already done something close to that: […]
Well, there you go. Thanks for the link. From the article:
While we find that peoples self-assessed risk tolerance and ProQuest RTS generally accord, there is considerable variation with a tendency for respondents to underestimate their risk tolerance. This suggests that financial planners who rely largely on subjective assessments of risk tolerance run the risk of suggesting inappropriate, and in the majority of cases overly conservative, investment strategies for their clients.
This might mean that typical questionnaires also underestimate risk tolerance.
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Re: Risk Questionnaires: How they work?

Post by 555 »

nisiprius wrote:Image
I've seen this one in Risk Questionnaires before, and it is a real howler. Option B has higher reward and lower risk than Option C. It is an absolute no-brainer to prefer Option B over Option C, no matter how risk-tolerant you are. I was gobsmacked when I first saw this question. It would be insane to choose Option C in real life, but since you know it's just a Risk Questionnaire you can guess need to choose it if you want to find out their recommendations for the more risk-tolerant.

The question "would you accept higher risk to get higher expected return" is a risk-tolerance test.

The question "would you accept higher risk to get lower expected return" is an intelligence test.
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Re: Risk Questionnaires: How they work?

Post by Uncle Pennybags »

nisiprius wrote:I agree. And "framing" is particularly interesting, because every risk tolerance questionnaire I've seen seemed to frame the questions in a way designed to encourage taking risk.

During 2008-2009, stocks dropped a bit more than 50%, and almost everyone I know experienced it that way--about a 50% loss.
Why would Vanguard want one to take more risk? Their stock funds have a lower expense that their bond funds. As for the loss question it was a one year loss, I assume a tax calender year, the biggest ever one year loss for the S&P was -38.49% in 2008. Stocks fell 80% from 1929 to 1933.

I find these questionnaires suggest a more conservative allocation than I have. My age throws them off but I'm a wild and crazy guy.
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Re: Risk Questionnaires: How they work?

Post by digarei »

Uncle Pennybags wrote:Why would Vanguard want one to take more risk?

I find these questionnaires suggest a more conservative allocation than I have.
Bingo. I concur. This has been my experience with risk tolerance questionnaires from Vanguard, Nationwide, Aon Hewitt and others.
nisiprius wrote:every risk questionnaire I've seen frames the questions in such a way as to avoid asking about a 50% loss, but some other, smaller number.
The hypothetical "investment" does not refer specifically to a stock holding. I took it to mean all of ones holdings — a portfolio. I don't remember my portfolio suffering a 50% loss during 2008-2009. So, it's a truer reflection than how you have characterized it.

As to the color of the bars----please! If they used fire-engine red, then the company would open themselves to charges of being alarmist! I'm guessing that salmon just happen to fit the Navy blue tone somewhat better.
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Re: Risk Questionnaires: How they work?

Post by Uncle Pennybags »

digarei wrote:As to the color of the bars----please! If they used fire-engine red, then the company would open themselves to charges of being alarmist! I'm guessing that salmon just happen to fit the Navy blue tone somewhat better.
They didn't use green for gain so it must have been an artistic choice and not a physiological one.
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Re: Risk Questionnaires: How they work?

Post by Epsilon Delta »

digarei wrote: As to the color of the bars----please! If they used fire-engine red, then the company would open themselves to charges of being alarmist! I'm guessing that salmon just happen to fit the Navy blue tone somewhat better.
On my screen the loss bar is the same color as Nisiprius's Monarch, which is pretty alarming (or so a little bird told me).
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