With more than $10 billion in assets under management, Wealthfront is one of the most popular robo-advisors around at the moment, thanks to its straightforward and competitive advisory fee of 0.25% and comprehensive financial planning tools. If you’ve already signed up for an investment account with this platform but aren’t sure what your Wealthfront risk score is all about, this article should shed some light on how it impacts your portfolio.
To present you with a personalized diversified portfolio based on your financial goals and attitude to risk, you’ll have been asked a range of subjective and objective risk-related questions during the sign-up process. You’ll have been assigned a risk score after Wealthfront’s sophisticated technology evaluated your answers and your recommended portfolio will be directly linked to your risk score.
How does Wealthfront work out your risk score?
Several elements influence your risk score. One of them is how consistent you are at answering questions related to risk. If you state that you’re happy to take a high level of risk in one area, but not another, this shows inconsistency in your answers, and you’ll be assigned a lower risk tolerance score as a result.
Wealthfront uses objective questions to estimate whether you’ll have enough saved at retirement age to afford your future spending needs. If you’re likely to have plenty of excess income, your risk tolerance will be greater than someone whose retirement fund isn’t expected to cover their outgoings in their golden years.
Wealthfront’s overall risk score combines both subjective and objective risk tolerance and gives a heavier weighting to the component that is more risk-averse. Risk scores range from 0.5 to 10.0 with the latter relating to the most risk tolerant. The lower your score is, the more risk averse Wealthfront assumes you to be.
Each risk score relates to one of twenty asset allocations with target volatilities ranging between 5.5% to 15.0% per year.
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Your risk tolerance will be based on the answers you gave via the questionnaire you filled in when you signed up to Wealthfront. Whether you think your score should be higher or lower is really your call, but know that the technology used to determine your risk score is smart.
If you’re pondering over whether your existing risk score will allow for a good enough return, you might want to check out an online tool that is available on the Wealthfront website where you can view historical pre-tax returns based on various risk scores.
As an example, a risk score of 5.0 on a taxable portfolio has previously seen a return of -1.41% after one year, a 5.89% return after three years and a 4.74% return over five years. Whereas a risk score of 10.0 could see a -3.41% return after one year, 7.0% after three years and 4.63% over five.
Check out Wealthfront’s historical performance tool here.
Yes, you can change your risk score and ultimately the allocations you’re investing in. However, there should be a good reason for doing so and trying to time the market isn’t one of them. Wealthfront states that you should only change your risk score/risk tolerance if your personal circumstances change.
For example, if you get married, have children, lose your job or get a better one, these are all life events that may have an impact on your investment strategy and attitude to risk. (Read their advice in full here)
If you do change your risk score in a taxable account, Wealthfront’s software will make the transition to your new allocation as tax-efficient as possible, which may mean that trades won’t happen straight away. If you have a retirement account and you change your risk score, Wealthfront will attempt to rebalance it within one business day.
Wealthfront’s investment strategy favors a long-term passive investing approach. Once your portfolio is set up, you can, in theory, sit back and hopefully watch your money grow, without having to do very much at all. (On the basis that Wealthfront has recommended a portfolio to suit your needs.)
However, if your attitude to risk should change and you find yourself wanting to get a bit more hands-on with your portfolio, the option is there to review how your investments are performing and potentially change things up.
It’s always worth reviewing your investments once or twice a year, but not too often – Wealthfront believes that checking too frequently is bad for your financial and mental health!
*We hope you find this information useful, although it shouldn’t be taken as investment advice. We recommend seeking advice from a professional financial advisor before making any investment decisions.
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