Sometimes there’s a disconnect between the financial profile answers provided by investors and how they react in real life
On questionnaires and in advisor meetings, be honest with yourself in terms of objectives and risk tolerance
Keep your advisor apprised of changes to your financial situation
When building a portfolio, “know thyself” is one of the most important rules. In order to construct the right mix of investments to help you pursue your investing goals, most portfolio managers will work with you to complete a questionnaire designed to help you determine your financial goals and risk tolerance.
The problem is, says Keith Denerstein, director of guidance, product management at TD Ameritrade Investment Management, LLC sometimes there’s a disconnect between the answers given by investors and what they do in real life.
“The TD Ameritrade Investment Management questionnaire provides the information needed to recommend a managed portfolio to a client. And in some cases, to tailor a portfolio to a client’s financial goals,” says Denerstein. “If your responses don’t match your actions, then your portfolio might not be appropriate for you.”
How Do Your Answers Help Determine Which Portfolio is Right for You?
When filling out the profile questionnaire, you’ll see questions about your goals and the time frame you have established for them. There are also items that address your ability to tolerate risk. Your answers help to determine the portfolio that’s recommended for you (see figure 1 below).
“For those willing to take on more risk or those who have many years until they will take disbursements, a more aggressive portfolio might be recommended,” says Denerstein. “However, if the money is being invested for a shorter period of time, a growth and income portfolios might be recommended.”
If you think you can handle a higher degree of risk, but then sell investments when the market falls, you could end up selling at a low point in the market and suffering investment losses. Being realistic about your situation as you fill out the questionnaire can help you feel comfortable about sticking to the plan, even when a market event might lead to an emotional response.
Why Is There a Mismatch Between Investor Answers and Behavior?
“At the time an investor completes the financial questionnaire, the mindset tends to be rational and analytical,“ says Denerstein. “However, when the market is falling rapidly, the investor might panic and make decisions based on emotion. It’s easy to get swept up and behave differently than you thought you would.”
FIGURE 1: RISK PROFILE. It’s important to accurately gauge the level of risk with which you are most comfortable to ensure your portfolio is tailored to your needs. Source: tdameritrade.com. For illustrative purposes only.
According to Denerstein, the investing questionnaire is designed to help the client evaluate his risk tolerance using hypothetical scenarios about losses. The questions prompt investors think about how they might react if they thought their portfolio might see significant losses.“We typically show gains versus losses in a way that investors can understand,” Denerstein says. “The challenge most investors don’t know how they’ll actually behave when the moment arrives.”
It’s not just a personal misunderstanding that can lead to a mismatch between you and your portfolio, though. Denerstein points out that a change in your financial situation or life circumstances can affect the way you act later.
“If you’re experiencing a change, your behavior isn’t going to match up with your state of mind when you originally filled out the questionnaire,” said Denerstein. “You might need to re-evaluate your answers to reflect your current situation.”
How to Fill Out a More Meaningful Investing Questionnaire
As you fill out the questionnaire, Denerstein suggests taking a step back and thinking about how you’ve behaved in tense situations. “Look back and think about a time when you were stressed about the market. Did you behave like you thought you would? Use that as a guide as you fill out the questionnaire,” he says.
Denerstein also suggests changing percentages into dollars when answering questions about risk tolerance. When the question asks about a loss of 30% of your portfolio, look at what investments are currently worth and put a dollar figure to it. So, if you have a portfolio of $500,000, that 30% loss translates to $150,000. How would you feel if your portfolio lost that much in a falling market? Would you still be comfortable?
Finally, Denerstein encourages investors to review their investments at least annually. “It’s possible to adjust your questionnaire answers later,” he says.
“Stay on top of your portfolio and let TD Ameritrade Investment Management know about any changes in your life or financial situation that may affect your investing approach or outlook,” Denerstein continues. “You can change your answers to the questionnaire to reflect your new circumstances, and your portfolio recommendation can be changed to help you pursue your updated financial situation.”
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