THE ABSOLUTELY BEST RISK PROFILE QUESTIONNAIRE

I LIED- THERE ISN'T ONE


Here is the issue with literally all the risk profile measures. They are based upon your (limited) knowledge of risk and reward and what you would LIKE TO DO, what you WANT TO DO or WHAT YOU HAVE DONE IN THE PAST. These may be diametrically opposed to what you NEED TO DO. Further, that once you got the appropriate knowledge or used a competent adviser, your actual decisions might be radically different than what you had previously assumed. It's just that most of the knowledge necessary to adequately develop the risk scenario is not provided- or not provided in adequate depth- with literally all the profile questionnaires I have seen . They universally start with a budget- usually far too simplistic. They also require a present value analysis which rarely incorporates the areas that are unique to YOU. So, in my opinion, they don't work that well.

For example, here is a real life example- and there are many many more. A widow, age 45, who could not work, was left with life insurance proceeds of roughly $300,000. She had no experience in investments, but clearly was entirely risk adverse. She wanted something safe and secure which literally all the risk profile measurement programs would provide. Her husband's agent suggested letting the insurance company make annuity payouts. The problem was in order for her to live her actuarial lifetime, she would NEED far more money than any conservative investment could provide. Yes, there are some simplistic software packages that might be able to measure what she might require, but, I submit, they could not properly address the pension she would get at age 62, Social Security at age 60, adjustments for the budget as the children got out or college or moved away, her health conditions and more.

In essence, there was nothing in the materials I have seen that would have led her to the direction she NEEDED to take which was a lot of growth funds, coupled with some bond funds that had a good spin-off of income and that also addressed adjusting the costs of college, managed care, etc.

The more "normal" violation involves those that are the risk takers and supposedly want the greatest return for the buck. Invariably, however, they tend to be men who seem to have taken a shot of testosterone shortly before completing the form. Since they want high risk, the forms tend to indicate what funds or stocks fit that profile and sale. While higher risks are acceptable for those with no dependents, etc., many of the conclusions are categorically improper for those with a family, limited emergency funds, and, certainly, limited knowledge of investments. Most people have no idea of the fundamentals- nor does it appear the people making up these profiles do either- and some serious financial problems may arise, particularly for a family with children, no insurance, etc. I suggest that anyone that can pass the investment quiz might have appropriate knowledge of investing. Otherwise they may have violated the investment pyramid and the mutual fund pyramid. (Actually, such sales are ILLEGAL but they are rarely enforced by the NASD or the SEC- probably because they couldn't pass any of the quizes either.) In any case, we have another profile showing the investments he/she would LIKE to buy, not what the should or NEED to do.

As a separate item, included in many software packages and on line services, the results may focus on the viability of variable annuities and variable life insurance. But they, almost universally, rarely address the taxation of the assets as they are taken out. Most certainly, they never address the taxation of the assets if they are retained by the client till death. For example, buying a variable life policy can work under certain conditions, but do not expect your beneficiaries to ever get the full proceeds from the policy .

If you want to view a couple risk profile analyses, here are a couple direct links to American Express, Fidelity and Vanguard. Or buy Quicken, something from Parsons technology, Dow Jones- there's tons of others in every software catalog. Use a bunch of these and perhaps compare the results one to the other. It's a lot of work, and, yes, I do use these every so often. But it's the personal insight that is needed to correctly determine your ultimate risk profile and WHAT YOU NEED TO DO.

FIDELITY RISK PROFILE/ ASSET ALLOCATION LINK (Reviewed 1997, 11//98, 12/00, 11/02- why bother. In less than 5 minutes with 13 questions I was able to calculate my "asset   allocation".   That's not proper  planning. That's a sales gimmick) 

PRUDENTIAL RISK ANALYSIS  (Reviewed 11//98, 12/99, 12/00, 11/02). Here is what they asked- For each statement, choose the response that most accurately reflects your feelings or behavior. And that's the problem. There are little, if any "feelings" with investments. It's essentially pure research. (I am fully aware of the psychology of investing and know full well that feelings are a main determinant of investing. It's just that it shouldn't be. I have little emotion in reviewing stocks, funds, allocation, etc. My main concern is if I know what I am doing and have I done the analysis definitively.) As regards your prior "behavior", so what. I am concerned about what you need to do and change in the future- not a reflection and continuation of bad history. 13 effectively useless questions designed for a sale, not planning for a future. As of 11/02, you apparently have to be a client in order to get to the risk tolerance section

AMERICAN EXPRESS RISK PROFILE ( Reviewed 7//97, 11/98, 12/99, 12/00, 11/02- 12 Questions to determine your investments for years. Now it is 8 questions. Ridiculous, absurd, stupid)

BANK OF AMERICA RISK PROFILE/ASSET ALLOCATION (Reviewed 11/98, 12/00 11/02. Initially a wasted effort with 12 simplistic questions. Now its 11. They also include this comment which is troubling with every fund- "The overall level of risk you choose is based primarily on your tolerance to assume risk in exchange for potential rewards." The problem is that nobody defines risk and consumers don't have a clue to what they are doing.)

VANGUARD ASSET ALLOCATION:  (Reviewed 11/98, 12/99, 12/00, 11/02. They note- Your asset allocation decision will also be influenced by your attitude toward investment risk. Your attitude is important, but perhaps should be overcome by proper planning. That's why you have to read further. What is comical is that Vanguard actually puts the number of minutes before each session of "learning" so you know you won't be there too long. Heaven forbid some intensive effort was required.) They have effectively switched the analysis to Financial Engines

SMART MONEY ASSET ALLOCATION : (Reviewed 12/98, 12/99, 12/00, 11/02. Look at the amount of cash they suggest when you try various strategies and ages. While that certainly limits risk, it tends to simply define what you want to do, NOT WHAT YOU NEED TO DO. Heavy exposure to cash severely reduces your return and it may be that you need to be heavily invested in securities in order to live out your lifetime as you require. Certainly, high cash positions can reflect various market conditions, but I think it just reveals another undisciplined approach to allocation.  IT'S THE RETIREMENT BUDGET THAT CONTROLS RISK ANALYSIS).

THIRD AGE ALLOCATOR : (Reviewed 12/99, 12/00, 11/02) It provides four scenarios-

arrowYoung, I've got decades before I retire?
arrowPrime of life or approaching retirement?
arrowRetiring soon or already retired?
arrowIn my fourth age, over 70?

But look at the "retiring soon or already retired". I am not suggesting the use of some bonds is not valid, but do you really want 45% in that category?  (In 2000- 2003, it is prudent but not simply because you were old. See added comments below) Over the last three years it earned less than 6% annually and was a negative in 1999. Perhaps you can sleep well with about half your portfolio doing dismally, but can your budget???  (2001 Note: Due to the poor economy before the WTC, I changed the bulk of equities over to bonds. That doesn't mean my clients avoided losses up to that point in whatever equities remained. However, I had been reasonably confident that the 7 adjustments by the FED would finally "take hold". Once it became clear that any recovery was NOT going to happen that year, and that further significant losses would occur in the 4th quarter, I made adjustments to fixed income positions which I have kept till current. No, bonds do not outproduce stock over time. But there are certain times they are beneficial and prudent. This is such a time.  Always remember 1973/74. Also consider this- per a 11/02 analysis by Deutsche Bank, it estimates there's only a 23 percent chance that U.S. stocks will outperform bonds over the next 20 years. Think hard about what you just read and add it to any allocation you might attempt in the future.)

At age 70, it suggests 60% bonds. But the overriding point may be is that sufficient earning power for a remaining actuarial lifetime of "x" years? (Do you know how long an actuarial lifetime might be at any age????) If you can "guarantee" you will die in 8 years, perhaps 60% in bonds will be adequate. But if you plan on living longer- just your actuarial lifetime of 12+ years for a man and 15+ years for a woman- the static allocation may lead to destitution in the final years of life. Not a good way of leaving the earth when it could possibly be avoided.

In my opinion, don't ever rely on just a form or some computer to design your investment strategy or the rest of your life. Computer programs are fine for crunching numbers, but they rarely incorporate real life personal issues. You need to unemotionally and objectively determine what you NEED to do. If you are not capable of doing that in a detached  and knowledgeable manner, hire someone that can.

COMMENTARY ON AN ACTUAL FORM DEVELOPED BY IBBOTSON

Patterns of returns for various levels of risk

                     No Risk           Low Risk          Moderate         High                       50% Moderate and High

Yr. 1              4.00%  $1.04  1.00% $1.01     2.00% $1.02     22.00% $1.22       12.00% $1.12

Yr. 2              4.00% $1.08    4.00% $1.05   8.55% $1.11      14.00% $1.39        11.28% $1.25

Yr. 3              4.00% $1.12    2.00% $1.07   14.50% $1.27    -12.00% $1.22     1.25% $1.26

Yr. 4              4.00% $1.17    8.00% $1.16    -2.50% $1.24     35.50% $1.66     16.50% $1.47

Yr. 5              4.00% $1.22    5.00% $1.21     6.00% $1.31      1.30% $1.68       3.65% $1.52

AVG              4.00%               4.00%                5.71%                12.16%               8.94%

CMPD           4.00%               3.97%                5.55%              10.93%                 8.79%

STD DEV.      0.00%                2.74%               6.45%              18.35%                6.31%

WRST RET    4.00%               1.00%                -2.50%              -12.00%             1.25%

Rebalancing: Dick Thaler [of the University Of Chicago 2004] had suggested that an optimal period for reviewing your performance was 13 months. Actually what Dick was saying is that for people who have invested for the long run, the optimal period is several years. If you are highly diversified, then you may do better by just not looking at the intervening results, because responding to fluctuations will lead you to be too active. What Dick found is that you can explain the behaviors of the market as a whole by assuming that many people—I think that applies to institutions more than individuals—have the horizon of about one year. That is, they think of the outcome of current investments in terms of gains and losses where the horizon is about one year.

I don't agree with that contention. If you purchased bonds in 1993 and let them ride, you would have been devastated by the losses as interest rates rose. I suppose someone could say that you had good diversification in 1993 but holding onto guaranteed losses is a substantial emotional risk as well.

O.K., take a look at your situation now. Did you have good diversification before 2000? Did you do it properly after 2002? So what about now as rates rise. Do you wish to hold onto them now? Sure, you may have to take some tax hit on any gains in the bonds at a sale. But better to pay a tax on a gain than to take a loss altogether.