Riskalyze

Here is a free program, Riskalyze, that creates a portfolio for you which first analyzes your risk tolerance and then creates a portfolio for you. You start by selecting one of the following choices:

Source: Riskalyze

You begin by specifying a "desperation amount."  This is an amount that, if you fall below it, will have a negative impact on your lifestyle - sort of like being in Vegas and keeping in mind that you need a certain amount to make it back home.  Seriously, though, this is an important number to consciously think about as you enter the investment arena.

As you see, I put in a portfolio value of $200,000 and a "desperation value" of $150,000:

Source: Riskalyze

Note the pictures and risk scores.  The old guy has a low risk score of 28, the professional woman a risk score of 45, etc.

Next you get a series of questions comparing alternatives, comprised of taking a sure gain or preferring an uncertain situation of a much higher gain (hit the ball in the upper deck) or dropping back to your "desperation value."

Here is the first alternative:

Source: Riskalyze

As you choose among these alternatives, the bar will eventually fill up and you'll receive a risk score.  I have to admit that I have never liked answering these types of hypotheticals as a means of uncovering risk tolerance.  I would rather look at past behavior and study historical returns.  I will say, though, that Riskalyze's approach may work well for some people and, admittedly, it is based on academic research.

The next set of choices will seek to present you with a case where you start out with your portfolio dropping.  Would you, in that instance, seek to take a chance to regain your position?  It proceeds through these kinds of questions to get at a risk score.

Source: Riskalyze

As you can see, once you get a score it gives you a range of potential returns for a typical portfolio.  The process is based on modern portfolio theory.  Thus, it is saying that the average portfolio for this risk score will fall within the indicated range based on 2 standard deviations from the average.

So, quantifying in this way can be useful for some people.

At this point, Riskalyze asks if you have a prediction for the market or if you would like to use historical returns.  After you pick, it will then construct a portfolio based on your choice in the first graphic above.  What I really like is that - as seen in the first graphic above- it allows for a simple portfolio.  This is the route I would definitely choose unless you want to make managing your portfolio a full time job.

Overall, this is an interesting program and one I think most DIYers will find useful to play around with. Try and see how different it is compared to what you are doing.