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Quantifying vs. Qualifying Risk and Fees

Don Anders (2)Have you been asked a question like this:

 

“On a scale from 1-10 what is your risk tolerance?”

OR

“Are you a Conservative, Moderate, or Aggressive investor?”

 

This is what is called “Qualifying” risk tolerance. Qualifying is great for advisors looking to sell certain plans or products, because it’s a completely subjective scale. A “7 Risk Tolerance” means something completely different to a 25-year-old FOREX trader and a 65-year-old retired teacher. From my experience in the profession, these subjective questions are often used as a sales tool rather than an accurate client suitability tool.

Instead, I recommend that advisors and individuals “Quantify” risk and fees instead of “Qualify” them. Why? Because quantity is not subjective and is much more easily understood. Not only are scales subjective, but most people have a hard time actually putting percentages into large numbers.

Example: If you have $250,000 would you be comfortable if your account went down by $95,000 (-38% which is what happened in the S&P 500 in 2008) in a year? If the answer is “Yes, that wouldn’t bother me if I have the potential from long-term growth,” then that client is a good fit for a higher risk equity based portfolio, but most retirees are not comfortable with those types of fluctuations.

This is a much more accurate way to assess the client’s risk tolerance, but quantifying is also a much better way to inform clients on the amount of fees that they’re paying.

Example: If you have $250,000 and you’re paying 2% in annual fees, that means that you’re paying $5,000 per year in fees or $50,000 over the next 10 years, assuming no growth or loss.

If you’re not sure about the quantity of risk or fees inside your investments, feel free to reach out to our office and we’d be glad to give you a complimentary account check up using real numbers to help you understand what you own.