So, a great deal of thought needs to go into the format of the questionnaire, the structure of the questions themselves, and the statistcal testing of the question set to help ensure we are specifically measuring what we want to measure.
Firms looking at potential third-party tools should therefore consider who designed the test, how has the validity and reliability of the test been established, how long has the test been used and how does it identify inconsistent answers.
Are there alternative approaches?
As well as potential issues with the tool itself, there is of course the risk that a client’s answers can be flawed, which is why I strongly believe that it is a key part of the adviser’s role to ensure that the client is fully engaged with and fully understands the process and questions.
There are other methods which purport to be more objective than risk questionnaires, because, for example, they are founded on measuring someone’s experience or past behaviour in this context. But, that does not necessarily mean they are more valid. Let’s briefly look at a handful of alternative approaches.
Multiple Price List method (Holt and Laury, 2002)
This method provides clients with choices and they make decisions until a tipping point is reached regarding their risk tolerance.
It can be problematic because of something behavioural scientists call extreme aversion bias, where the client continually opts for the safe, middle option.
One example here might be going to the cinema and choosing a regular bucket of popcorn, avoiding choosing the small or large bucket. In that way, the client is not fully considering the true valuations of the price list they have been provided with, or the real consequences of their choices. It could also be argued that the Multiple Price List method does not measure a client’s capacity for risk.
A ‘financial anamnesis’ (Klement, 2015)
This approach is similar to how a doctor would look at a patient’s background and family history to discover more about them. But of course, this method can be unreliable when the aim is to understand more about the individual client, not their family or any stereotypes.
Investment history
We can, of course, look at the individual’s investment experience. Nearly all financial planners would pick this up through their general discussions with a client, and indeed Dynamic Planner’s risk questionnaires do consider investment experience as part of a complete, holistic approach. On its own, though, this method has problems, most obviously if the individual has never invested before, or if their circumstances have changed significantly since their last investment.
