If you’ve ever walked into a financial planner’s office or a brokerage firm, chances are you were handed a “risk assessment questionnaire," or something like it. The purpose of the this quiz is to assess how much risk you are comfortable with when it comes to investing.
To determine your risk assessment profile, you'll proceed to answer questions such as:
“Would you be willing to take risks in order to meet your long-term financial objectives or would you rather protect your principal at the expense of future gains?”
“Would it be acceptable to experience a 30% loss if it was followed by a 30% gain later on?” (We’ll be looking at this question in more detail below).
“Will you need this money in ten, twenty or twenty-five years?”
A computer program will then use this information to assign you a risk tolerance label such as “moderately conservative” or “aggressive.” A chart will then be generated with recommendations to “diversify” your assets into a variety of stocks, bonds and/or mutual funds.Here are the problems with this all-too-common scenario:
1. Only a limited menu of investment options are presented.
2. Psychological pressure is brought to bear on the consumer by the risk assessment process.
3. The client is forced to act based solely on conjecture and speculation (otherwise known as guesswork).
4. The future performance of conservative, moderate or aggressive portfolios is also nothing more than a “best guess”.
5. An illusion of security is fostered by risk assessment profiles.
6. An acceptable loss for whom?