How I’m Building Scalability Into My Practice
It’s been five months now since my journey began and I am finding the transition from employee to business owner requires a lot of time and energy. Last week I wrote about my efforts to develop a strategic plan. This week I continued working on the plan and started some specific projects, which, once created, can easily be replicated.
I have been working to develop tools, templates, process, and procedures that will provide scalability. This “scalability” is a critical component of a business’s efficiency. The tools that we sometimes take for granted as an employee have to be created or purchased when you are an independent. A risk tolerance questionnaire is one of these basic tools.
For years I believed that people overstated their ability to tolerate risk. This was confirmed when I attended an FPA conference in Denver in 2004. One of the speakers was Dr. Daniel Kahneman, Nobel laureate in 2002. He suggested that people have a tendency to overstate their risk tolerance and referred to it as their coefficient of loss aversion. I’ve looked for a questionnaire that incorporated this, but have been unsuccessful. Since necessity is the mother of invention, I decided to create my own. Here’s how I approached this project.
My new questionnaire has 12 questions and each answer has an assigned point value. The maximum possible points are 52 and the minimum is 14. The difference between the minimum and maximum number is 38 and I have 9 model portfolios. When you divide 38 by 9 you get 4.22. So there is now a grid with a minimum of 14, which increases in increments of 4.22, until it reaches 52. Depending on where the client scores it will assign them to one of the nine portfolios. The adjustment for their coefficient of loss aversion is accounted for in a few of the questions. After the answers are input, this process, which is now automated in Excel, creates a multi-page proposal, customized for that particular client. This can now be used with any client and takes very little time to reproduce.
I have several other projects in the works, at various stages and will keep you informed on their progress.
Your risk questionnaire and process is very interesting. What are chances of getting a copy?
Several years ago I built a risk tolerance for a very successful RIA firm.
I looked for research that showed what percent amount clients could stomach in losses. I never did find any but if you know of sources please let me know. Saddly, I found many in the industry to admit that it was mostly to CYA the firm. Many times the advisor told the client what answer to select. I don’t blame the advisor for this because the questionnaire did little to assess the client’s risk.
I believe more research in this area is critical if an advisor were to really assess his clients true risk tolerance. I think the biggest gap is between the risk tolerance questionnaire and the matching of that with investment models.
My question: How can an advisor really assess a client’s risk tolerance if there’s no benchmark? And without a benchmark: How can you say that a 15% loss is a Moderate Risk Portfolio?
Several years ago I built a risk tolerance for a very successful RIA firm.
I looked for research that showed what percent amount clients could stomach in losses. I never did find any but if you know of sources please let me know. Saddly, I found many in the industry to admit that it was mostly to CYA the firm. Many times the advisor told the client what answer to select. I don’t blame the advisor for this because the questionnaire did little to assess the client’s risk.
I believe more research in this area is critical if an advisor were to really assess his clients true risk tolerance. I think the biggest gap is between the risk tolerance questionnaire and the matching of that with investment models.
My question: How can an advisor really assess a client’s risk tolerance if there’s no benchmark? And without a benchmark: How can you say that a 15% loss is a Moderate Risk Portfolio?
Good comments. The purpose, in my view, is not to CYA but to assess the clients risk tolerance as accurately as possible. I don’t think clients relate to a gain or loss in percentage terms as well as they would in dollar terms. Also, it’s important to relate the gain/loss potential of the account in the context of their overall wealth. Dr. Kahneman discusses this issue of framing the problem. For instance, instead of saying the account may lose $X or gain $Y he would say your net worth, as a result of this account (in part), may decline to $X or increase to $Y. On the issue of the gap between the risk Q and the model portfolio, I use MCS to simulate the performance of the account for various periods. This “range” is broken out into deciles and I use this to illustrate the potential variance of the account (even though there may be outliers). What do you mean by a benchmark?
Thanks.