The Reign of the Risk Score: Is it Too Powerful in Financial Planning?
In the world of financial planning, one number holds a significant amount of power: the risk score. This metric, often determined through a risk tolerance questionnaire, is used by financial advisors to allocate assets in a client’s portfolio. However, some experts argue that the reliance on risk scores has gone too far.
Noah Damsky, founder of Marina Wealth Advisors, boldly stated that the industry’s use of risk scores is “absolute trash.” He believes that risk scores provide only a high-level indication and should not be the sole factor in determining asset allocation.
A recent white paper from Nebo Wealth further supports this argument, suggesting that the industry has become too dependent on risk scores. The paper highlights the disconnect between clients’ financial goals and their investment portfolios, calling for a more balanced approach that considers factors beyond just risk tolerance.
Martin Tarlie, a portfolio designer at Nebo, emphasizes the importance of incorporating the “three pillars” of investment — required rate of return, risk tolerance, and time horizon — into the decision-making process. While risk scores are still relevant, they should not be the sole determining factor.
Critics like Damsky take it a step further by completely disregarding risk scores in their practice. He believes that the way risk scores are calculated is flawed and that clients are not always accurate in self-reflecting on their risk tolerance.
On the other hand, David Shotwell, president of Shotwell Rutter Baer, sees risk scores as a starting point for discussion but not the final decision-maker. He believes that risk scores provide insight into a client’s mindset for risk and help facilitate meaningful conversations about portfolio risk.
Ultimately, the debate surrounding risk scores boils down to the need for a more holistic approach to financial planning. While risk scores can offer valuable insights, they should not be the sole factor in determining asset allocation. By considering a client’s individual circumstances, goals, and objectives, financial advisors can create more personalized and effective investment strategies.
