Risk Tolerance Questionnaire FAQ
Why Totum Risk?
Totum is the only multi-dimensional risk tolerance questionnaire and toolkit that helps advisors understand how much risk their clients can comfortably take based on their life situation. With Totum, you can easily customize how you engage with your clients and have in-depth discussions about their Risk Preferences, Risk Capacity, and Portfolio Risk.
Our questionnaire goes beyond simply measuring clients’ Risk Preference to consider the factors that truly make each individual unique including: goals/time horizon, career stability, industry exposure, health and related risks, local cost of living and income potential, and many more.
This risk clarity closes prospects faster, helps win additional assets from existing clients, and serves as a necessary reassurance when anyone has doubts.
What problem does Totum solve?
While advisors have begun to embrace technology, realizing that there are a number of solutions that can dramatically improve the efficiency of their practice, there are still some areas lacking clearly superior technological solutions.
Totum revolutionizes the risk profiling experience by employing a thoughtful yet concise questionnaire to gather the data necessary for our complex, quantitative risk model.
The multi-dimensional risk clarity saves advisors time by expediting a deeper investment and planning conversation.
How is Totum different from other products on the market?
There are a slew of products on the market which claim to tackle the question of client risk profiling; however, the vast majority of these focus exclusively on Risk Preferences or only ask enough broad questions to recommend a generic portfolio allocation without effectively understanding what makes an individual unique.
On average a household experiences one life event a year. Totum understands these events in creating a truly bespoke solution for each client. We also think it is important to distinguish between clients’ Risk Capacity, or how much risk they can afford to take, vs. their Risk Preference, or how much risk they want to take.
How do we look at portfolio risk?
Traditionally, standard deviation has been one of the most prevalent measures of risk in investment management. While it is a valid measure of a portfolio’s total volatility, since market and portfolio returns are not normally distributed, relying purely on standard deviations may underestimate the potential for loss.
Comparing normal distribution with the historical return distribution of a number of indices illustrates that the actual distribution has a fatter left tail. In other words, large negative returns happen more often than what standard deviation would indicate.
This is the driving reason behind our creation of our proprietary Totum Risk Metric.
What is behind the Totum Risk Score?
Our proprietary Totum Risk Metric measures the VaR(Value at Risk). Once calculated, using portfolio returns back to 2000, the portfolio Risk Metric is mapped to a Totum Portfolio Risk Score ranging from 1-99 with descriptors from “Defensive” to “Aggressive”.
How can I explain the Totum Risk Score?
If you are familiar with the cholesterol numbers, one measures total cholesterol and another measures the bad cholesterol. Instead of using standard deviation, which measure total risk including the “good risk”, the Totum Risk Score gives more weight to the “bad risk”.
While the measure of 2 standard deviations is often used to mean 95% of the time (2 standard deviations in normal distribution covers 95.45% of the distribution), you can think of the Totum metric as looking at more of the downside using the Sharpe Ratio, or how much the portfolio can lose during a usual market downturn.
How does Totum measure Risk Tolerance?
FINRA defines “Risk Tolerance” as “a customer’s ability and willingness to lose some or all of [the] original investment in exchange for greater potential returns.”
The prevalent practice of measuring just the willingness for risk, or the psychological tolerance is insufficient, as this can be quite different than the losses the client can withstand given their unique personal and financial situations.
To be consistent with the guidance of FINRA’s suitability rule and the SEC’s Best Interest Regulation Rule, our client risk score measures both a client’s willingness, what we call “Risk Prefernces”, and the ability, or “Risk Capacity”, to lose money for potential gains.
How do you compare client Risk Tolerance and portfolio Risk?
In order to compare the client “Risk Tolerance”, against the risk of a portfolio, we use a unified metric for both the client and the portfolio: Loss Potential. In other words, we are comparing how much the client can or is willing to lose in exchange for upside with how bad the portfolio drawdown can be in a market cycle.
For the client, it’s the lessor of their “Risk Appetite” and “Risk Capacity”. This matches up against portfolio risk where we calculate the proprietary Totum Risk Metric, that gauges both the total volatility and the downside potential of the portfolio.
What are the asset class ranges in Totum Risk?
Totum Risk Scale ranges from 1-99 with the following category breakdowns.
Moderately Conservative (21-30)
Focus Growth (71-90)
S&P 500 Index scores around a 70
Barclays Aggregate Bond Index scores around 14
The Totum Risk questionnaire
There are 11 questions full text and 9 questions on the mobile friendly version. You can add your own custom questions on the full text questionnaire to learn more about a prospect or client.
The first four questions 1-4 cover the FINRA 2111 Suitability rule.
- Age and Income
- Number of people in the household and number of dependents (IRS tax breaks)
- Annual expenses and net worth (calculators are available in the question)
- Investment amount and time horizon
The next four questions 5-9 cover Risk Capacity. Data is being used in our algorithm from the previous four questions to assess the overall risk scores as well as other resources such as the Cost of Living Index, IRS, CDC, US Census Bureau, and more. (scoring backed by research from Morningstar, Fidelity, and more… Totum includes three types of Risk Capacity, 1. Base risk, 2. Human risk, 3. Financial risk
- Location, Primary residence. Provide zip code only and check the box if you own property
- Career, what sector do you work in, if you are retired, select Retired
- Consistency of Income (over 12 months)
- Health (80% of the wealth in the US is owned by the age group over 55 years of age)
The last three questions 9-11 cover psychological and behavioral Risk Preferences. Again, data is being used from the previous eight questions to assess the overall risk scores. (scoring backed by research from multiple Economic Nobel Prize winners including Daniel Kahneman and Paul Samuelson)
- How much are you willing to lose over the next 12 months for future gains(slider)
- Flip a coin question, gains
- Flip a coin question, loss aversion
Totum Risk scores the Risk Preference to show the investor how much risk they are willing to take at this moment in time and scores the Risk Capacity to show the investor how much risk they should or should not be taking based on their life situation. Totum then scores the investor’s portfolio to show them how much risk they are currently taking on a scale of 1 to 99( Baclays aggregate bond index scores a 14, less risk, and the S&P 500 index scores a 70, more risk). The premise of the scores is to make sure the investor’s portfolio falls between the risk preference and risk capacity scores, but closer to the risk capacity because it has a longer time frame and it shows us the investors ability to take risk. (risk capacity is more in line with financial goals, is more static, is based on facts not emotions or market conditions, and on average annually every person or household has one life event that impacts their overall investment risk objective)
The Totum Risk questionnaire was built by PhD’s in the industry who utilized research from other Noble Economic Prize winning psychologists and economists. More data was added to the methodology from leading financial institutions to build an active – client friendly risk questionnaire with a robust and compliant back end. Totum Risk’s methodology is US patent pending.
Totum believes the risk scores are not the end all be all. The advisor may find out through a financial plan that the investor needs to take on more risk or less risk than what the risk tool showed us. The advisor can then go back into Totum and move the risk preference score to be more inline with the financial plan. For compliance reasons the change in the risk score is time stamped and archived with the advisor’s notes.
There are a lot of questionnaires out there, what's different here?
There are a lot of questionnaires out there from robo-advisors to robo-hybrids, there is no doubt about that. Unfortunately, a lot of them are woefully inadequate in that they are only addressing one aspect of risk at any given time. Some are only considering a client’s appetite for risk and others are purely looking at potentially investments based on a timeline until retirement.
The questionnaire from Totum allows you to assess a client’s risk from both a Risk Capacity and Risk Appetite perspective at the same time in a truly holistic way.
How can so few questions give a holistic risk score?
Questionnaires don’t need to be long to give an accurate assessment of what makes a client unique. In fact, a longer questionnaire actually becomes problematic if clients don’t have enough interest to make it all the way through, which undermines the entire process. We carefully selected these questions as the bare minimum inputs for our model as well as gathering enough information to help you start an intelligent planning conversation.
In the future, we will be adding to this questionnaire to further delve into the unique aspects of each client’s life, which will give an even more comprehensive and accurate risk score. This will all be done through data mining and machine learning.
Why not just use the last 5-10 years of data?
This return period (2000 – last month end) is chosen intentionally for understanding long-term loss potential and recovery during different economic and interest rate regimes. This time period captures two complete stock market and economic cycles, as well as both rising and declining inflation and interest rate environments.
As we are not always able to predict the interest rate and equity market environment going forward, it’s prudent to consider the return and correlation characteristics of all four scenarios when advising clients with a long-term investment strategy.
What happens if a security didn't exist during a given time period?
If the inception date of a security is after the period in question, the time period prior to inception is replaced by an ETF that tracks the asset category of the security. An asset category is largely based on stock industry sectors or domicile if the security is a stock, or Morningstar Category if the security is a mutual fund or ETF, and is a more granular categorization than the broad asset class.
The ETF selected usually has the longest history, the best liquidity and the lowest expense ratio. If the ETF that represents the asset category also started after the given time period, then the period prior to the ETF’s inception is replaced with the index returns of the asset class that the security belongs to.
How can Totum be integrated with my current systems?
We are currently integrated directly with custodians, broker dealers and other third party FinTech providers. This allows Totum to pull client account portfolios and financial information in to automatically score each security and portfolio.
We understand that the best software is fully integrated and does not interfere with your normal workflow. For that reason we’ve developed an aggressive integration plan for the remainder of 2019 and into 2020.
Further integrations in 2020 will look to include direct custodial feeds, trading and rebalancing software, portfolio management platforms, and more.
Can I integrate client accounts and data?
Ease of data entry was paramount when creating Totum.
Whether you’re adding model portfolio(s) or actual client accounts, you can automatically upload them from excel into Totum by simply selecting the file(s) or select the integrations tab and then select any custodian, broker/dealer, bank, insurance firm, or third party fintech vendor. Totum will upload all of your client account data for you.
How can I be sure my clients' information is safe, secure and private?
How is your system designed?
Our cloud-based (SaaS) product is accessible across all devices and optimized for mobile (app coming soon)
Flexible open architecture, modularized, and REST APIs.
Intelligent stack: java, json, and react delivers real-time, visually stunning feedback of complex analytics
256-bit Bank Level encryption
AWS (Amazon web services) SOC 2 & 3