There are two ways to measure how well you are doing in your investment account: In percentages or in dollars. Which feels worse: “I am down 5%” or “I am down $50,000”? For a $1,000,000 portfolio those are one and the same, but it is much more frequent that I hear down moves described in dollar terms 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 is harder to quantify: Risk. In the past, investors were asked about their tolerance for risk by checking Conservative or Aggressive, or on a scale of 1-10. The problem has been 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!
There is now 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 our tolerance for risk in a unique way. Here is how it 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.
Riskalyze does three things that help support better outcomes for investors. It creates greater self-awareness by asking questions based on the numbers that matter. Everyone’s definition of being conservative or aggressive is different and this helps to focus on how each person identifies with risk. Riskalyze also helps us to understand if an investor’s expectations and their 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. Finally, it helps us as planners to go back to the financial plan and model the returns and risks that a client needs to take to reach their goals.
If you would like to see how it works for yourself, click here (Riskalyze) to complete the questionnaire and learn your Risk Score.
Disclosure: Riskalyze, Inc. is a third-party unaffiliated technology company. The information presented is for general purposes only and is not meant to be construed as investment advice. This material includes the proprietary information of Riskalyze and is not warranted to be complete or accurate. Except as otherwise provided by law, neither Morton Brown nor Riskalyze shall not be responsible for any damages or losses resulting from the use of this information. For a full evaluation to determine which investments may be appropriate for you, contact Morton Brown Family Wealth, LLC, a Registered Investment Advisor with the U.S. Securities and Exchange Commission.