When it comes to risk profiles, don’t trust client surveys

Advisers would be better off using a holistic approach to determining a client’s risk tolerance instead of traditional surveys.

“Asset allocation is about deciding how much to put in risky assets and how much to put into safe assets,” Tom Idzorek, director of research at Ibbotson Associates Inc., told advisers at the 2012 Investment Management Consultants Association conference in New York.

Traditional risk tolerance surveys don’t tell enough about an individual to determine how to position his or her portfolio, Mr. Idzorek said. “It’s not going to tell you what’s going to let them sleep at night,” he said.

Instead, advisers need to look beyond what their clients say is their risk tolerance, and consider their preferences and capacity for taking on risk.

People with a steady, predictable stream of income, such as tenured university professors, could afford to take on more risk in their portfolio since their human capital isn’t volatile. “Their income stream is like a bond,” Mr. Idzorek said.

But people whose income is more volatile, such as those dependent on sales commissions, should be more conservative in their portfolio because there’s more risk in their human capital.

Keeping clients’ portfolios on track is also paramount. “Most investors forget about their risk tolerance when the market is going up and get too conservative in a downturn,” he said.

The “dramatic” returns of 2009 and 2010 returned about 80% of the value that was lost in 2008 for investors who stayed in a stable portfolio, according to Ibbotson.