Are Risk Tolerance Questionnaires Too Risky?

Chris Carosa of Fiduciary News raises interesting and disturbing questions about the risk tolerance questionnaires used not only by many major DC providers but also by many advisors — especially those looking to comply with FINRA’s suitability standard. Citing academic research as well as anecdotal evidence, Carosa noted that most investors test out either too aggressive or too conservative based on their current financial situation and face the risk, for example, of going broke safely.

Robert Arnott, in a controversial interview, said that TDFs that get too conservative close to retirement are missing opportunities just when investors’ account balances are their largest — losing up to 20% of possible returns.

So if risk-based questionnaires are too risky and TDF allocations are too broad, what’s the answer? Advisors working with individuals is one obvious solution, but that’s expensive and might get even more so if the DOL’s redefinition of fiduciary goes through, edging out most commissioned brokers in qualified plans and IRAs. Another alternative is LDI, which takes into account a participant’s age, salary, account balance, deferral rate, investment allocation and whether a DB plan is available — all data currently available on most record keeping systems. What LDI doesn’t take into account, though, is outside assets.

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