Updated Saturday, October 25, 2014 as of 8:20 PM ET

What's Wrong With Risk Assessments: Willingness vs. Need

In the past year or so, Iíve personally taken two risk profile questionnaires. The first, by Vanguard, pegged my stock allocation at 70%, while the second, from Wealthfront, put me at 91% stocks and commodities. In reality, Iím about 45% in risky assets and not about to change.

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Comments (3)
The real problem with risk tolerance questionnaires is that they arbitrarily define "risk" as "market risk" and ignore all other forms of risk that we face as investors. That may work will in a CYA sense for FINRA and for the industry, but does a gross injustice to most investors.

Alan says that "stocks are far riskier than high quality bonds". Really? That is true if you equate "risk" to "market risk", but that slight of hand aside, is that really true. Indeed, while it is unquestionably true that stocks may decline in value, it is hard to imagine that interest rates won't rise over time. In that case, what will happen to the value of those "high quality bonds"?

Alan goes on to invoke the decline in value of stocks during the great depression, but it is worth bearing in mind that in Bill Bengen's famous analysis, it was not the investor who retired in 1949 who funds did not last his lifetime, but the investor who retired in 1968 who was devastated by the inflationary 70s.

Does this mean that we should ignore market risk? Of course not. What it does mean is that we should be wary of minimizing one kind of risk (market risk) in a manor that dramatically increases other forms of risk (inflation risk, interest rate risk, longevity risk, etc.). Sorry Alan, we don't live in a risk free world. While we can seek to manage risks, we can not avoid them.
Posted by David M | Tuesday, May 13 2014 at 2:15PM ET
Excellent distinction between reality and perception by clients, Mr. Roth. Now if you would only acquire some understanding about equity indexed annuities and the ability to be honest about them.
Posted by Gary D | Tuesday, May 13 2014 at 2:25PM ET
Interesting, and the author's experience with risk questionnaires and generic risk assumptions is similar to mine. However, his generalized assessment of which asset classes are considered 'risky' is a bit dated. The bond market has enjoyed some relative stability for 30+ years, but under current market conditions, "stocks are far riskier than high-quality bonds" just doesn't fly right now. Particularly when it comes to bond funds - which is where the majority of moderate-wealth individual investors hold their bonds.
My safe (safer) money is deployed assets that are not directly correlated to the stock nor the bond markets. I'm sure I'll return to bonds at some time in the future, but I'll wait until that market stabilizes.
Posted by don g | Wednesday, May 14 2014 at 4:16PM ET
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