Portfolios & risk
What a risk score does not measure
One number, produced from a questionnaire, standing in for three separate questions. It presents well, and it does not measure the other two.
Published
What the questionnaire is good at
Capturing disposition. How someone describes their relationship with volatility, in a calm room, with nothing happening.
That is real information and it belongs in the file. It is not nothing.
The first thing it misses
Capacity. How much loss the plan can absorb before the plan stops working.
Capacity is arithmetic. Time horizon, required withdrawals, fixed obligations, and flexibility in the goal. It has no relationship to how the client feels, and two people with identical questionnaire answers routinely have completely different capacity.
The second thing it misses
Behavior. What the client actually does when the decline is happening rather than hypothetical.
People are poor predictors of their own conduct in conditions they have not experienced. The questionnaire asks them to be exactly that.
The distinction has a name and a full statement: The Three Risks.
Why the score moves
Administer the same questionnaire to the same person in a rising market and a falling one and you will frequently get different answers.
Part of the score is the date it was taken.
What to do with it
Use it as one input. The rest — capacity from the plan, behavior from the record, and a written reconciliation where the three disagree — is stated once, on The Three Risks.