Learn all about the Risk Tolerance Questionnaire, Methodology, and additional FAQs
Introduction
The Risk Tolerance Questionnaire is a crucial tool in Advisor Core for understanding your clients' investment goals, timelines, and comfort level with risk. This guide will walk you through the questionnaire process and explain how the results are used to determine an appropriate investment strategy.
Download the Risk Tolerance Questionnaire
Guide to the Risk Tolerance Questionnaire
Purpose
The questionnaire evaluates two key aspects:
- Risk Capacity: The client's ability to endure financial losses based on their financial timeline.
- Risk Aversion: The client's psychological willingness to take on risk in their investment portfolio.
Questionnaire Structure
The questionnaire consists of 8 multiple-choice questions covering various aspects of risk tolerance:
- Primary financial goal
- Investment experience
- Timeline for withdrawing money
- Expected duration of withdrawals
- Perception of financial risk
- Willingness to take financial risk
- Reaction to market volatility
- Comfort with potential investment outcome
Scoring
- Each answer is assigned a point value, with some questions weighted more heavily than others.
- The questionnaire calculates two scores:
- Risk Capacity Score: Based on questions about timeline and financial goals.
- Risk Aversion Score: Based on questions about risk perception and behavior.
Interpreting Results
- The overall Risk Tolerance Score is determined by combining the Risk Capacity and Risk Aversion scores using a specific scoring matrix.
- Scores are categorized into five risk profiles:
- Conservative
- Moderately Conservative
- Moderate
- Moderately Aggressive
- Aggressive
Using the Results
- The Risk Tolerance Score helps determine the appropriate asset allocation for the client's portfolio.
- It informs the selection of a "best fit" portfolio from your model portfolios or guides the creation of a custom portfolio
FAQ
How long does it take to complete the questionnaire?
The questionnaire typically takes 5-10 minutes to complete.
Can clients change their answers later?
Yes, clients can retake the questionnaire if their circumstances or preferences change. You can then update their profile and adjust their portfolio accordingly.
How often should clients retake the questionnaire?
It's recommended to review risk tolerance annually or when significant life changes occur (e.g., marriage, birth of a child, approaching retirement).
How does Advisor Core calculate the risk score for portfolios?
Advisor Core uses a Monte Carlo simulation to calculate portfolio drawdown, which is then mapped to a risk score. The simulation considers various market scenarios and calculates the 95th percentile of potential drawdowns. For securities with limited historical data, the system uses imputed returns based on regression analysis with similar securities that have longer histories.
What's the relationship between the questionnaire results and portfolio risk scores?
The questionnaire results help determine the appropriate level of risk for a client's portfolio. Advisor Core then matches this with portfolios that have similar risk scores based on their potential drawdown. It's important to note that portfolio risk scores apply only to the portion of each portfolio with returns coverage, which includes Equities, Mutual Funds, ETFs, and Cash.
Can I customize the questionnaire?
The current questionnaire is standardized to ensure consistent risk assessment across all clients. However, if you want to use your own firm questionnaire instead, you can manually enter the risk ratings of the prospect on Advisor Core
How does Advisor Core handle clients with no investment experience?
The questionnaire includes questions about investment experience, but it also considers other factors like financial goals and risk perception. Even clients with no experience can receive a suitable risk profile based on their other responses.
What if a client's risk capacity and risk aversion scores are very different?
This is not uncommon. In such cases, it's important to have a detailed discussion with the client to understand their unique situation and find a balanced approach that addresses both their financial needs (capacity) and comfort level (aversion). The overall Risk Tolerance Score is determined using a table that combines the Risk Capacity and Risk Aversion scores, giving appropriate weight to both factors.
How does the risk score relate to specific asset allocations?
Risk scores are calibrated to match the drawdown of standard portfolio allocations. For example:
- Conservative (Score ~10): 2% Cash, 78% Fixed Income, 20% Equity
- Moderate (Score ~50): 1% Cash, 39% Fixed Income, 60% Equity
- Aggressive (Score ~90): 0% Cash, 5% Fixed Income, 95% Equity
Can the risk tolerance results be exported or included in client reports?
Yes, you can include risk tolerance results in your customized client reports generated through Advisor Core. This helps provide transparency and justification for your recommended investment strategies.
Are all questions in the Risk Tolerance Questionnaire weighted equally?
No, the questions are not weighted equally. Each answer is assigned a specific point value, with some questions having a greater impact on the final score than others. For example, questions about investment timeline and financial goals (which affect Risk Capacity) may have higher point values than questions about investment experience.
Remember, while the Risk Tolerance Questionnaire is a powerful tool, it should be used in conjunction with your professional judgment and in-depth discussions with your clients to ensure the most appropriate investment strategy.