WHY CLIENT RISK QUESTIONNAIRES ARE POOR INDICATORS OF WHAT A
CLIENT
SHOULD DO
Long time readers know that I have always indicated that the
questionnaires
put out by literally all the fund families, financial planning software
companies, analysts, etc. do a poor job of determining what an investor
SHOULD
or NEEDS do. They invariably focus on what an investor WANTS to do. In
order
to provide more detail, I took a questionnaire from one of the most
recognized
analysts in the business- Ibbotson Associates (it was used for John
Hancock
1998) and provided commentary for each question asked. But the cynicism
is
essentially the same for Fidelity, Vanguard, Quicken or any form.
1. INVESTMENT GOALS: "Your goal is $_______. Your total savings for this goal is $_________.
Commentary- this is O.K. since it is basically gathering information.
However,
I would ask how much is currently being invested on a monthly basis.
It's
at least as important as the current amount saved.
2. International investments are often added to a portfolio for
additional
diversification. Would you want international investments to be part of
your
portfolio? Yes No
Commentary- it is a true statement that international investments
provide
diversification, but my concern is that the investor- at least the type
that
has to fill out this type of questionnaire- simply has little idea as
to
why. Overhearing someone talk at a cocktail party about how well
someone
has done in Hong Kong stock provides no insight for the use of an
international
fund. Sure, some can say that this is an introductory overview for a
client,
BUT THIS WILL BE USED TO DETERMINE A PROJECTED FINAL
ALLOCATION. Based
on the answers, the forms generate the "ideal" type of allocation that
the
client should utilize and the fund companies (normally) will have
everything
there for the client to purchase. But there is insufficient knowledge
about
any of the allocations on which to make a final determination.
3. Please indicate the approximate degree that you have used these
investments
in the past and whether you would invest in them in the future.
Commentary- again the ridiculousness of the questionnaire assumes
that the
client properly used any of the funds previously or knew what they were
doing
when they did. My point is that if the client has NOT used stock funds
before
it probably is due to the fact that they had no idea of what they were
doing
in the first place and may not want to use them at any time in the
future.
That's bad planning. Anyone that indicates that they have NOT
used
stock should be flagged immediately as to what they SHOULD be
doing/MUST
consider. Otherwise, the computer program may exclude stocks or give
only
superficial comments about the need for stocks.
4. Inflation can reduce your purchasing power by eroding the return on an investment. How do you feel about the impact of inflation on your investments?
Commentary- The form provides nothing to indicate just what inflation
will
do to an investment over time. They must provide what has inflation
been
and what is projected. And what have been the historical returns on
money
market funds, bonds, U.S. stocks and international funds. How is
someone
going to choose if they have no idea what the numbers are??? THEY
CAN'T!!!!
5. Over the past three months, your $10,000 investment has declined
to a
value of $9,000, resulting in a $1,000 loss. How would you react?
Commentary- Why did it lose? Was it a bum investment? Was it due to a
"standard"
market correction? Was it due to poor allocation? The question needs to
address
why the decline happened since that would primarily determine what the
investor
SHOULD OR NEEDS to do. Since effectively none of the questionnaires
address
that, the question- at least for my position- is sophomoric and
useless.
6. The (graph) shows the possible returns of four different $10,000
over
a one year period.
Portfolio A- Best gain= $750. Worst gain= $250
Portfolio B- Best gain = $1,500. Worst loss = $250
Portfolio c- Best gain + $2,250. Worst loss= $750
Portfolio D- Best gain = $3,000. Worst loss $1,250
Which would choose to invest in?
Commentary- actually I don't have much problem with this in its
graphical
context. It actually reflects a form of standard deviation. But the
question
focuses on the use of ONE investment, not how they might be
combined
together to provide the correct allocation. With that missing, I don't
think
it does a good job.
7. When purchasing automobile insurance, I look for a policy with
Commentary- This might be O.K as a reflection of basic risk.
8. Which of the following statements do you feel best describes you
as an
investor
Commentary-Notice that all the questions ask the investor what he
prefers
to do- not what he/she SHOULD OR NEEDS TO DO. I categorically state
that
is a sham. A budget determines
how
much discretionary income is available and/or how much money may be
available
for the future. With those numbers, one then determines if the most
conservative
investments will work or if more aggressive investments are mandatory.
I
have done this with many clients who may be the most conservative type
of
investors since they may never have been in the market. But when you
look
at people living till 80 or 90, they don't have a choice as to what
they
HAVE to do (stocks) irrespective of what they would like to do (money
market
funds). Without identifying this issue, any questionnaire is a waste.
9. You held a portfolio of stock, bond and money market investments
(but
a money market fund is NOT an investment) that has increased in value
by
7% this year. The general stock market has increased by 15% over the
same
period. What would you do?
Commentary- first of all, a 15% return is an anomaly- the return over the past 50 years is 10%+. And why did the market go up- was it due to lower interest rates, great dividends, was there an election, what??? Further, if you look at the return of 7% overall it may mean that essentially very little was invested in stocks. For example a 20% position in stocks x 15% return = 3%. If bonds represented 50% and a return of 7%, that would provide a 3.5% return. Together that's 6.5%. That means that the other 30% was in money market funds earning 1.7% overall (30% x 1.7%= 0.5%). Well, that doesn't work.
If I use 30% stock for a 4.5% partial total and the rest in money market funds, it would have earned 3.6% (70% x 3.6% = 2.5%)- which is far more realistic. But since the allocations are not identified and/or don't make sense, the suggestions that a potential investor might do X, Y or Z is without merit.
Those were all the questions. Now the investor hits the SUBMIT button and the allocation indicates "your results will compare your current asset allocation with a suggested asset allocation that can help you reach your goal without compromising your tolerance for risk."
Rubbish.
PROSPECTIVE INVESTORS ARE BEING LED TO INVEST HARD EARNED MONEY WITHOUT A BASIC UNDERSTANDING OF RISK AND REWARD. THE FORMS LOOK VALID AND ARE GREAT MARKETING TOOLS FOR THE SALE OF FUNDS. BUT I SUBMIT THAT IS NOT GOOD PLANNING AND A FRAUD ON THE PUBLIC.