“Rule No.1: Never lose money.
Rule No.2: Never forget rule No.1.”
– Warren Buffett
It happens thousands of times a day across America: An investor walks in a brokerage house or financial planner’s office and is handed a brochure that explains their “Risk Assessment Profile,” along with a questionnaire. They sit down and have to come up with answers to questions they may have never given thought to before, such as:
“Would you prefer to protect principal at the expense of future gains, or are you willing to take risks in order to meet your long-term financial objectives?”
“Are you comfortable having a 30% downswing if there is a 30% upswing?”
“When do you need money? In five, ten, fifteen, twenty, twenty-five years?”
The computer spits out a risk tolerance label such as “Aggressive” or Moderately Conservative,” and a pie chart recommending “diversification” of assets into a variety of stocks and/or mutual funds, and bonds.
There are several big problems with this scenario:
1. The system only promotes and recognizes ridiculously narrow investment choices.
It assumes that stocks, bonds, are the only options. And your financial professional would know best, right? It’s important to realize that they are often really just “investment representatives” – salespeople for financial products sold by large corporations – not unbiased advisors. Even certified, fee-based planners tend to be very myopic, too hesitant or uninformed to recommend any out-of-the-box investments.
Therefore, the consumer assumes that stocks, bonds and mutual funds are the “best” options, when in truth, they’re simply the only options on a limited menu. The investor can only choose how to divvy up the money in the pie chart categories, not whether or not they’d prefer a different flavor of pie altogether.
2. The risk assessment process exerts not-so-subtle psychological pressure on consumer.
Remember the Milgram experiment? People are extremely hesitant to speak up when the “authority” tells them they must proceed. How many investors might feel that risks are unnecessary and undesirable, yet are afraid to speak up in the presence of a “financial expert” or a spouse who feels differently?
You’re told you have 30 years for the miracle of compound interest to work its magic, you’re told you have time to take some level of risk… “Sure, you think, “I’m not retiring for decades, so I can afford to be aggressive,” as you are encouraged. Nobody wants to appear like a financial “wimp,” especially when the program of stock market investing is presented as some rite of passage for financially savvy adults.
3. It’s all pure guesswork on the client’s part, based on conjecture and speculation.
Who can really predict how they will feel about losing money, or anything they haven’t yet experienced? Just because someone enjoys motorcycle racing or improv acting doesn’t mean they’ll be able to stomach financial risks. And yet, they are forced to consider hypothetical questions and give answers that will determine their investment plan for many years to come.
4. How the “Conservative,” “Moderate,” “Aggressive” or other such portfolios will actually perform is all guesswork, too.
The recommendations are based on past performance of the same or similar investments, a dubious way to predict future performance. Perhaps you’ve heard… “past results are no guarantee of future performance.”
One Registered Investment Advisory firm asserts on their website, seemingly oblivious to the irony, “We don’t believe in guesswork when it comes to your risk.” Boasting “a technical approach to investment planning and management,” their clients select from 32 possible responses. Each selection is given a numerical value, then added together to obtain the risk assessment score that will dictate their financial strategy. Very scientific indeed!
But while the advisory firm doesn’t wish to “guess” as to an investor’s risk tolerance, the scenarios they ask clients to evaluate are nothing BUT guesswork. Notice that none of the following options presenting A) conservatively moderate, B) moderate, C) moderately aggressive or D) aggressive portfolios allow for or even suggest a possible 45% or 50% loss, as many investors experienced from 2008-2009. The imaginary $100,000 portfolio appears to have a finite range in which it can grow or shrink:
5. Risk assessment profiles give investors false sense of security.
The way in which the options above are presented intentionally leads investors to think that the financial planner must know that these recommended portfolios won’t lose more than 5%, 10%, or 20% (for the most aggressive choice)… right!?
A lot of people truly don’t know – or believe – that they could lose 50% of their portfolio value, and those that have, don’t think it’s likely to happen again. Surely 2008-2009 was a freak accident, a rare crime, and not a sign of the new times of runaway Wall Street excesses, speed trading, and high stakes gambles with other people’s money.
The financial planner will probably not remind the investor that even Mr. Value Investor himself, Warren Buffett (often criticized for being too conservative in his investment strategies) failed tremendously, right along with the common investor. Shares of Berkshire Hathaway tumbled from their Sept 2008 high point of 147,000 to an all-time low in March 2009 of 70,050 – a loss of more than 52% in approximately six months! And though the stock has recovered steadily since, it has never come within even 10% of its former December 2007 all-time high of 151,650.00. (So much for Rule #1.)
So if Warren Buffett, the most profitable investor of all time, could be ambushed by a Wall Street crash, do you really think that a financial planner with a questionnaire and a computer program can predict the future and assure your investments any kind of “safety”?
Whose Risk Are the Risk Profiles Mitigating?
It is hard not to conclude that risk assessment profiles are a way to avert the risk of the financial planner and stock broker, not the investor. As Tamris, a financial consultancy firm explains, “An investor enters a wealth and asset management relationship with expectations. If these expectations are not carefully managed and assessed by the advisor there will be conflicts later on in the relationship.”
Risk assessment profiles provide a convenient way to ask investors to sign a document acknowledging that you have authorized them to design an investment strategy that has a chance (or even a likelihood) of losing some of your money. If you don’t like the performance of the investments, the onus is on you. After all, the financial planner only invested your money as requested, in funds deemed “appropriate” for your level of risk tolerance, according to your risk assessment profile.
Brokers and financial planners are sued all the time for fraud, misconduct, and incompetence, such as failure to disclose risks, or putting a client’s money in inappropriate investments (such as putting a retiree’s portfolio in pure stocks.) But if Grandma told a brokerage to be “aggressive” in writing at age 65, the broker has some protection when she re-thinks her risk inclinations after losses.
Ultimately, risk assessment profiles are a way of influencing us to believe a whole list of financial lies and half-truths, such as:
• Safe investments can’t earn favorable returns.
• Those who win big in the end are those who are comfortable with “aggressive” investment strategies.
• Risks are necessary if you want to want to have a chance of ever “retiring.”
• It is a normal and acceptable part of investing to give over control of your money to others until you “need it” for retirement.
• Your financial planner’s job is to help you assess how tolerant you will be of market losses, not to protect you from having any losses.
• The financial world is dangerous and complicated, and you need financial professionals to simplify it for you.
Are you ready to hear the TRUTH? Then you’ll definitely want to read the brand new book from the Prosperity Economics Movement, Busting the Financial Planning Lies. This book reveals why the wealthy ignore the advice doled out by Wall Street and typical financial planners, and shows you how to take back control of your thinking… and your money!