Why Risk-Profile Questionnaires Don’t Work

In constructing financial plans, I tell clients that the second most important decision they will make is to set the overall riskiness of their portfolio by deciding upon an asset allocation. I’ll disclose the most important decision at the end.

As a financial planner, I’ve been trained to administer what’s called a “risk profile questionnaire” to new clients to determine how much of their portfolio should be in more volatile asset classes like stocks. One of the best such questionnaires I’ve seen is this survey from Vanguard. It asks questions about how clients feel about risk and when they will need their money, with the answers supposedly determining how much risk to take.

Though I’m trained to use these questionnaires, I don’t and here’s why – as well as a better way.

I love the idea that risk tolerance is something that can be quantified by answering certain questions that magically reveal what your asset allocation should be. I’m opposed to using them, however, because reality indicates they don’t work. For example, the Vanguard survey said I should be 80% in stocks, while other surveys I’ve taken put me as high as 90% stocks. The lowest stock allocation I received from a questionnaire I took recently came from Riskalyze at 55% stocks.

According to these questionnaires, I should be between 55% to 90% stocks. Yet I won’t budge from my current target of only 45% stocks for three reasons:

1. Our inconsistent desire to take risk

After more than a 10-year bull market, most of us feel pretty confident. It’s easy to feel brave when everything is up. Not so much when stocks plunge. That’s the time when we tend to want to load up on cash. Had I taken these surveys on March 9, 2009 when stocks bottomed out, I would have had a much lower appetite for risk. In fact, data shows advisors fall into the trap of taking on risk after markets surge only to pull risk off the table after a plunge.