Most attempts to measure risk tolerance fail in at least one crucial way, be it confusing the measurement, confusing the audience, or thinking guesswork is a good enough replacement for rigorous psychometric science.The difference between a faulty test and a good one is often in the testing - in scientific terms, how reliable and valid are the items selected for inclusion, and how well does the set work as a whole?Beware of measurements that, mix in traits other than risk tolerance, measure financial understanding, or provide inconsistent, unstable outputs.
By conflating risk tolerance with behavioural risk attitudes, advisers will potentially replicate (or optimise for) all the silly things investors do already, rather than helping to mitigate and control investors’ more-destructive tendencies.A common failure of risk profilers is to try to elicit separate measures of tolerance for different subcomponents of a client’s overall wealth.If we genuinely want to determine the right amount of risk, it is not sufficient just to measure risk tolerance. It is also not sufficient to supplement this with a narrow model of risk capacity. We also need to help people understand, articulate and dynamically adapt their future goals, plans and aspirations over their journey.
Profiling outputs should not be set to match the 7-point scale used in KIIDs.There is little point to profiling investors with more granularity than you can provide solutions for; there is no 'best' number of buckets into which divide investors, but there are options that are definitely worse than others.Enforcing a single standard on risk-profiling outputs is likely to stifle valuable innovation in profiling methodology and lead to a regulatory environment that remains flawed and dated.