A Measure of Risk

For a $1,000,000 portfolio those are one and the same. However, much more frequently I hear down investment moves described in dollar terms. Why? Because it feels like actual money lost. That focus makes sense. Percentages don’t pay the bills, dollars do.

Investor focus on dollars gained or lost brings up two very important behavioral issues:

• All performance measures look backwards, which has limited value in making decisions about the future.
• Measuring performance in a way that feels more painful (dollars) means investors run the risk of making emotional decisions.

What if we were able to measure our investing progress in a healthy way that helps us to make good decisions along the way? It would mean looking at more than what just happened in the markets. We would have to take into account a topic that which is harder to quantify: RISK.

Measuring Risk

In the past, investors were asked about their tolerance for risk by checking a box: Conservative or Aggressive. That or indicate their risk tolerance on a scale of 1-10. The problem is that these questions get answers that are often gut feelings and rooted in a bias toward recent events. It’s hard not to feel a little more bullish when the markets are racing ahead!

Now, there is a better way to quantify risk and have a positive impact on our behavior. We use a financial technology tool called Riskalyze that has been developed to help frame investor risk tolerance, measuring risk in a unique way. 

How riskalyze works

• Investors complete a questionnaire based on how much they have invested and how much they can stand to gain or lose (in dollars) over the next six months.
• They are then asked if they are willing to trade a little more protection for the sake of higher returns.
• By the end of the questionnaire, that willingness to trade safety for return generates a unique Risk Score on a scale of 1-100. That score will indicate a range of acceptable returns, both positive and negative, over a six-month time period.
• The investor’s portfolio is then given a score based on the risk and return profile of every stock, bond, or fund that they own.

At the end of the exercise, an investor can assess whether there is alignment between their tolerance for risk and the way they are actually invested. Someone with a Risk Score of 30 might be surprised to know that they are invested like a 70. The goal is to make sure we manage situations where fear or greed could emerge. If we understand what our investments could lose or gain in the short-term, we will be less likely to chase after higher returns or flee for safety at the wrong times.

measuring risk to support better outcomes for investors

Riskalyze does three things that help investors: 

1. Creates greater self-awareness by asking questions based on the numbers that matter. Everyone’s definition of being conservative or aggressive is different. This tool focuses on how each person identifies with risk.
2. Understand if expectations and investments are aligned. We will never know what will happen in the future, but if we understand what could happen, it will keep us from overreacting.
3. Gives advisors a reliable reference. As planners, we can look at the financial plan, modeling returns and risks that a client needs to take to reach their goals.