#10 Risk questionnaires and down markets

In our July 2021 web cast for Dimensional (Bringing the Matrix Book to Life), T.J. and I discussed risk tolerance questionnaires and a particular “flaw” that can block investors from reaching their goals. I can illustrate this using the Index Matrix app.

Let’s say a particular client indicates on a risk questionnaire that he or she cannot tolerate a 30% portfolio decline in any given year. This is almost always a fear-based response, not one based on expected withdrawals from the portfolio. In other words, long-term investors with diversified asset class portfolios–especially those with a high-quality, short-term bond allocation can tolerate a 30% decline if they don’t allow fear to derail their plan.

Below is a screenshot from the Index Matrix app for the period 2008-2021. The -36.7% return for the US total stock market in 2008 was a serious gut punch. But what we also see is that investors who did not panic and sell were positioned to realize an 11.2% compound rate of return (before costs) on those assets. Assets added the next year have compounded at 16.2%. This is an especially important perspective for 401(k) investors.

It’s important to understand the underlying principles here, since this illustration is based on an index (Fama/French US Market) and assumes performance starting on day one each year. Returns will always be different under different circumstances. But you get the point.


Share on facebook
Share on twitter
Share on linkedin

Leave a Reply