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Updating Risk Tolerance and How to Succeed with Your Financial Plan

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In 2014 we began using Riskalyze to help determine our clients’ tolerance for volatility in their portfolio (aka risk tolerance). This helped us decide what investment mix to place in client portfolios. Riskalyze used Nobel Prize winning economic theory to create a “Speed Limit” (1-99) at which to drive an investment portfolio—similar to driving down the highway. If you drive at 30 mph, your stomach doesn’t drop at the bumps and corners as much as when you drive at 75 mph. While the theory is sound, we’ve found that our clients don’t resonate with the application; because you change your speed depending on the quality of road you’re on (i.e. the current economic environment). 

Because regulators require us to gauge our clients’ risk tolerance annually, we’ll be updating risk surveys in a new way in Q1 2023. We are currently testing new tech that provides us two risk scores—one based on clients’ “risk preference” (emotional), paired with another based on your “risk capacity” (age, income level, net worth, etc.). The risk score in this case points to the largest expected decline in a portfolio: Simply, a 35 would mean in a bear market your portfolio might experience a 35% decline.

Since 2016 we’ve built financial plans with RightCapital, which uses Monte Carlo simulations to determine the “probabilty of success” of a financial plan. 

In the software, “success” is determined by still having at least $1 in your investment accounts at death. Naturally, most clients want 100% probability of success. We review very few plans with 100% confidence—there are far too many future variables. In fact, we are okay proposing a plan with greater than 50% probability of success: That means we (you and SFM) can make small tweaks throughout the rest of your life to help you avoid running out of money. But we understand that 51% feels like a failing grade.  

Under review is a calculation titled the “Comfort ZoneTM” which still calculates the “confidence level” (this should look familiar) alongside a graphical presentation of the Comfort ZoneTM, also showing clearly if you are overfunded or underfunded to meet your plan goals. Simple, yet effective.

Stay tuned as we review and implement important updates to our tech stack to better serve our clients.