risk tolerance assessment
Financial advising and risk tolerance assessment questionnaires go hand in hand when assessing a client’s risk preference. Those questionnaires help you decide exactly how you will be approaching that particular client’s case.
The problem with most risk tolerance questionnaires out there is that they don’t really give you the full picture. All the generic questionnaires on the market have deficiencies or issues in places where the firm can’t afford to take risks.
In fact, many questionnaires don’t take into account intangible factors such as biases. That is what we will be discussing in this blog.
Problems With Generic Risk Tolerance Questionnaires
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Herding
Herding is the mentality of following whatever is the current popular financial investment trend. Mass buying or selling of a certain asset due to panic or excitement is herding. And herding bias can have a severe impact on their answer when filling out the questionnaire.
Generic risk tolerance questionnaires don’t account for this.
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Loss Aversion
It is natural to fear financial loss. Especially when you don’t have a lot of assets to put up for investment. But there is such a thing as fearing loss too much or preferring the sure thing much more over the riskier options. This is known as “Loss Aversion”. It is also known as the Prospect Theory. This subconscious bias is also not accounted for in many questionnaires.
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Disposition Effect
There is also such a thing as holding onto an asset too long. The Disposition Effect says that there are people who prefer to quickly sell gaining assets while holding on too long to assets that are either stagnant or depreciating. This effect is also related to loss aversion, and it is another thing that needs to be addressed in risk tolerance questionnaires.
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Overconfidence
Though it is harder to quantify the phenomenon of an investor overestimating their own intellect or abilities when it comes to financial and investment decisions in quite common, there are many people who think that they know better than the market or people who have been working in the market for years.
The evidence of this points to the contrary. While there is nothing wrong with being self-assured, there is also no point in believing that you specifically know better. A 16-page study conducted by James Montier showed that of the 300 managers that took the test, 74% of them thought themselves to be smarter than the average investor. In contrast, the rest of the 26% thought themselves to be on an equal level. Not one person thought themselves to be below that, which is a statistical impossibility. That is why there is a clear and defined discrepancy in the equity portfolio returns of the average investor compared to the predicted output.
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Recency
Recency bias gets everyone. If something big happened in the financial market recently, then you can be sure that people’s decisions will be at least partially influenced by that event even if they don’t mean for it to happen. Either way, there are still many investment risk tolerance quizzes that fail to take this into account.
In Conclusion
Keeping all these biases in mind, we at Pocket Risk set out to create an investment risk tolerance test that aims to address these issues. We realise that it can be hard to quantify these biases, but it isn’t impossible. As such, we have developed our very own risk tolerance questionnaire. It is certainly the most well-rounded and comprehensive questionnaire that you will be able to find.
If your financial advisory firm is committed to maximising the comprehensiveness and efficiency of your client data collection process, we recommend using this quiz. Contact now for more details.