Tilting at Windmills: Risk Tolerance and Post Retirement Portfolios

Risk tolerance is a personality trait. It tends to be fixed by early adulthood. It generally doesn’t change significantly over a lifetime though it might after a financial shock such as a major market crash, divorce or retirement. Risk tolerance is likely to diminish a little with age but not materially, so any change should have little impact on retirement planning.

An individual’s risk profile is made up of three components which often don’t align: First, the portfolio consistent with risk tolerance. Second, the portfolio most likely to meet the client’s needs and third, the portfolio that best accounts for the client’s capacity for loss. The planner’s role is to help the client reconcile any differences between these three components.

In retirement, a client’s risk profile may change, but not necessarily. They still need to meet their short, medium and long-term needs. They still have to deal with market volatility; they still need to take into account their risk tolerance.

A 60-year-old client could have a 20- to 30-year life expectancy. She may have structured her portfolio prior to retirement with an eye to the future. She may remain with her pre-retirement portfolio because it meets her needs. Or she may not. The investment method adopted to meet her needs may need to change. She may elect to acquire an annuity and/or acquire income generating assets rather than those with an orientation for lower income and higher growth more common in a pre-retirement portfolio.

There’s no reason for psychometric personal risk tolerance houses such as FinaMetrica to change their risk tests. What we do need to do is explain that there’s no reason to add or subtract questions for retirees.

Risk tolerance is a trait. Retirement is a stage in life. Planning is a conversation around these two issues that may result in an investment recommendation. The investments per se have no role in the construction of the client’s risk profile. The selection of investment types in the portfolio is simply a consequence of taking into account the client’s age, circumstances and needs.