Risk Tolerance Questionnaire and Scoring System

Transcription

1 Risk Tolerance Questionnaire and Scoring System Ibbotson Standard Risk Tolerance Questionnaire Different investors have different risk tolerances. Much of the difference stems from time horizon. That is, someone with a short investment time horizon is less able to withstand losses. The remainder of the difference is attributable to the individual s appetite for risk. Volatility can be nerve-wracking for many people and they are more comfortable when they can avoid it. However, there is a definite relationship between risk and return. Investors need to recognize this risk/return trade-off. The following risk tolerance questionnaire has been designed to measure an individual s ability (time horizon) and willingness (risk tolerance) to accept uncertainties in their investment s performance. The total score recommends which of the five risk profiles is most appropriate for the investor. Investment History (not scored) What is your experience and overall knowledge of investments? A. I have no investment experience and a very low knowledge level regarding investments. B. I have very little investment experience and a fairly low knowledge level. C. I have some experience investing in mutual funds and am somewhat knowledgeable. D. I have some experience investing in mutual funds, individual stocks and bonds and am somewhat knowledgeable. E. I am an experienced investor and have a solid knowledge base regarding investments and am aware that markets can be volatile and unpredictable.

2 Page 2 of 9 Time Horizon 1. When do you expect to begin withdrawing money from your investment account? 1 year 1 2 years 4 years 5 7 years 8 10 years 11 years A. Less than 1 year B. 1 to 2 years C. to 4 years D. 5 to 7 years E. 8 to 10 years F. 11 years or more 2. Once you begin withdrawing money from your investment account, how long do you expect the withdrawals to last? 1 4 years 5 7 years 8 10 years 11 years A. I plan to take a lump sum distribution B. 1 to 4 years C. 5 to 7 years D. 8 to 10 years E. 11 years or more Risk Tolerance. Inflation, the rise in prices over time, can erode your investment return. Long-term investors should be aware that, if portfolio returns are less than the inflation rate, their ability to purchase goods and

3 Page of 9 services in the future might actually decline. However, portfolios with long-term returns that significantly exceed inflation are associated with a higher degree of risk. Which of the following portfolios is most consistent with your investment philosophy? A. Portfolio 1 will most likely exceed long-term inflation by a significant margin and has a high degree of risk. B. Portfolio 2 will most likely exceed long-term inflation by a moderate margin and has a high to moderate degree of risk. C. Portfolio will most likely exceed long-term inflation by a small margin and has a moderate degree of risk. D. Portfolio 4 will most likely match long-term inflation and has a low degree of risk. 4. Portfolios with the highest average returns also tend to have the highest chance of short-term losses. The table below provides the average dollar return of four hypothetical investments of $100,000 and the possibility of losing money (ending value of less than $100,000) over a one-year holding period. Possible Average Value at the End of 1 Year ($) Chance of Losing Money at the End of 1 Year (%) 110, , , , ,000 2 Portfolio A Portfolio B Portfolio C Portfolio D Please select the portfolio with which you are most comfortable. A. Portfolio A B. Portfolio B

4 Page 4 of 9 C. Portfolio C D. Portfolio D Probabilities After 1 Year 5. Investing involves a trade-off between risk and return. Historically, investors who have received high long-term average returns have experienced greater fluctuations in the value of their portfolio and more frequent short-term losses than investors in more conservative investments have. D C Portfolio Value B A Time Considering the above, which statement best describes your investment goals? A. Protect the value of my account. In order to minimize the chance for loss, I am willing to accept the lower long-term returns provided by conservative investments. B. Keep risk to a minimum while trying to achieve slightly higher returns than the returns provided by investments that are more conservative. C. Balance moderate levels of risk with moderate levels of returns. D. Maximize long-term investment returns. I am willing to accept large and sometimes dramatic fluctuations in the value of my investments. 6. Historically, markets have experienced downturns, both short-term and prolonged, followed by market recoveries. Suppose you owned a well-diversified portfolio that fell by 20% (i.e. $1,000 initial investment would now be worth $800) over a short period, consistent with the overall market.

5 Page 5 of 9 Investment Unknown 1,00 1,200 1,100 Initial Investment 20% decrease? 1, Year 1 Year 2 Year Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Assuming you still have 10 years until you begin withdrawals, how would you react? A. I would not change my portfolio. B. I would wait at least one year before changing to options that are more conservative. C. I would wait at least three months before changing to options that are more conservative. D. I would immediately change to options that are more conservative. 7. The following graph shows the hypothetical results of four sample portfolios over a one-year holding period. The best potential and worst potential gains and losses are presented. Note that the portfolio with the best potential gain also has the largest potential loss. Best potential gain Largest potential loss 50 41% 40 1% 0 24% 20 14% 10 9% % 16% 10 27% 20 Portfolio A Portfolio B Portfolio C Portfolio D

6 Page 6 of 9 Which of these portfolios would you prefer to hold? A. Portfolio A B. Portfolio B C. Portfolio C D. Portfolio D 8. I am comfortable with investments that may frequently experience large declines in value if there is a potential for higher returns. A. Agree B. Disagree C. Strongly disagree

7 Page 7 of 9 Questionnaire Scoring System Ibbotson designed the questionnaire scoring system to assign individuals to a portfolio based on their responses from the Financial Profiles risk tolerance questionnaire. The scoring system is unique since it focuses directly on the assetclass level model portfolios developed specifically for Financial Profiles. Like the questionnaire itself, the scoring system is divided into two distinct sections: 1. Time horizon score 2. Risk tolerance score Each section is scored separately, and then combined to form a total score. Ibbotson uses the total score to make the portfolio recommendation. The sections below discuss this process. Time Horizon Score The time horizon portion of the scoring is taken from questions 1 and 2. The score on these two questions determines the time horizon level. The time horizon level is used to assign various time horizon factors. Each time horizon level gives the investor access to certain portfolios and restricts the investor s access to others. Investors that score into the shorter time horizon levels are not given access to the more aggressive portfolios. This is consistent with Ibbotson s belief that individuals with shorter-term horizons should hold more conservative portfolios. Within each time horizon level, Ibbotson allows an investor s risk tolerance to determine the appropriate portfolio. If an investor s risk tolerance recommends a portfolio that is restricted (due to the time horizon level), Ibbotson recommends a more appropriate portfolio for that investor s specific time horizon level. This process allows conservative investors with short time horizons to score into a portfolio matched to their risk tolerance while at the same time protecting aggressive investors with short time horizons from excess risks. Risk Tolerance Score Find two scores. 1. Time horizon score 2. Risk aversion score

8 Page 8 of 9 We discuss this process below. Time Horizon Score Take the time horizon score from question 1 and 2. The score on these questions determines the time horizon level. The table below shows the point value of each answer choice in the time horizon section: * Note: You need this table and the formula that appears under it. Question 1 Question 2 A. 0 A. 0 B. 1 B. 2 C. C. 4 D. 7 D. 5 E. 9 E. 6 F. 11 Time Horizon Score = sum of values of Question 1 & Question 2 Risk Aversion Score Take the risk aversion score from questions through 8. Ibbotson assigns a point value to each response according to the investor s risk aversion. The highest points are awarded to the most aggressive answer choice. The risk aversion score ranges from zero (most conservative) to 100 (most aggressive). The points assigned to each question are as follows: * Note: You need this table and the formula that appears under it. Question Question 4 Question 5 Question 6 Question 7 Question 8 A. 18 A. 0 A. 0 A. 15 A. 19 A. 15 B. 12 B. 8 B. 5 B. 10 B. 12 B. 8 C. 6 C. 12 C. 10 C. 5 C. 7 C. 0 D. 0 D. 18 D. 15 D. 0 D. 0 Risk Aversion Score = sum of values of Question through Question 8

9 Page 9 of 9 Recommending a Portfolio The summary scoring grid below facilitates the final portfolio recommendation process by combining the time horizon and risk aversion scores. To use the scoring grid, find the time horizon score on the horizontal axis and the risk aversion score on the vertical axis. The intersection of these two points is the recommended portfolio. * Note: You need these tables. These are the only tables needed to map a person to a recommended portfolio. You will need to calculate the time horizon score and the risk aversion score, then use the grid to find the appropriate portfolio. Summary Scoring Grid Risk Aversion Score Time Horizon Score Portfolio 1 Portfolio 1 Portfolio 1 Portfolio 1 Portfolio Portfolio 1 Portfolio 2 Portfolio 2 Portfolio 2 Portfolio Portfolio 1 Portfolio 2 Portfolio Portfolio Portfolio Portfolio 1 Portfolio 2 Portfolio Portfolio 4 Portfolio Portfolio 1 Portfolio 2 Portfolio Portfolio 4 Portfolio 5