31 May Magic Questions on Risk Tolerance
Investors usually do not understand words like “Risk”, “Tolerance ” or the combination of these words.
Hence while assessing their risk profile it helps to ask questions that genuinely reflect their risk ability
Some key questions are:-
1) To what degree are you willing to deal with a drop in your portfolio?
Very basic question to assess ability to handle loss
2) What about repeated drops?
Basic question to assess ability to handle further loss. This provides the degree of risk tolerance
3) Have you ever lost any serious money that affected your lifestyle, plans, or sleep.If not, do you think that investment losses would affect your overall spirits, sleep habits, relationships, health, or work? To what degree?
This reflects whether the client has evidence to prove his risk tolerance or is it just what he currently believes to be his ability to manage risk. Because if it is the latter then he may behave inconsistently in the wake of a market meltdown when he actually confronts a loss even though it is notional in nature.
4) Has anyone in your family or close to you lost any serious money? If so, how did that loss feel to you? Did it affect your actions with regard to money?
This brings out his actual feelings and reactions because of the past experience. It could be that there was a loss and they handled it with a cool mind or it could be there was a problem and they all felt miserable and could never emerge out of it.
5) Are you willing to take more risk with discretionary income usually spent on non-essentials or toys or can you also touch your non discretionary income that is used to purchase essential goods and services if you have to achieve a big need of yours?
This shows whether he is actually risk tolerant or whether he is just ok to take on small risks
6) Do you and your spouse or partner see risk he same or differently?
This will indicate the journey you are likely to experience with the client. If he and his spouse see things very differently then during a meltdown you can expect indecision and undesirable behavior.
7) Do you care more about how well you do in terms of dollars accrued or how well compared with your friends and family?
This reflects whether the client is sorted out or not. A goal oriented client will be more stable in the investment journey compared to one who gets influenced by friends
8) Which is more important to you, beating the market or meeting your goals?
This would help you understand the client and his future reaction to market volatility. As long as he is goal oriented he will remain agnostic to market behavior in general and would make a better client then otherwise
9) Do you regard financial risk solely as the loss of money? Or do you consider lost Opportunity as a form of risk too?
This would tell you whether the client would go along with risky bets because he or she consider opportunity loss as a risk. For such people a little loss is ok but in the long term they desire to achieve more wealth