How useful are risk tolerance questionnaires?

Posted by Robin Powell on April 24, 2021

How useful are risk tolerance questionnaires?





From an investment standpoint, the role of an adviser is to construct a variety of portfolios with differing risk and return trade-offs, obtain an understanding of the investor’s preferences — including their attitudes toward risk and marginal utility of wealth — and then find the portfolio that is optimal for that investor based on their unique ability, willingness and need to take risk. 

Sam Sivarajan and Oscar De Bruijn contribute to the literature with their study Risk Tolerance, Return Expectations, and Other Factors Impacting Investment Decisions, published in the Spring 2021 issue of The Journal of Wealth Management. They began by noting: “Investor risk tolerance (primarily understood as the short-term volatility of investment returns) and time horizon are established through discussions with the adviser, as well as through questionnaires completed by the investor. However, stated investor preferences differ significantly ex ante and ex post market events such as the Great Recession — even when such market events are contemplated at the outset [emphasis mine]. Furthermore, industry experience and the authors’ own research suggests that the exact same investor, exhibiting the same preferences, will likely receive different recommendations from different advisers.”

In Sivarajan and De Bruijn’s study, “a two-phased approach was used to determine factors that drive risk-taking decisions by investors (primarily high net worth) and advisers in Canada. In Phase 1, quantitative data were collected from representative samples of investors and advisers using an online analytic survey. In Phase 2, the findings from Phase 1 were used to inform and design semi-structured interviews.” Their sample included 192 investors and 155 advisers. Following is a summary of their review of prior research as well as their own findings (my comments in italics):

  • Many risk tolerance questionnaires (RTQs) fail to accurately measure an investor’s risk tolerance and then to appropriately match the investor with the right portfolio.
  • Risk tolerance may not be a stable trait that can be accurately captured by a questionnaire—investors often act ex-post contrary to their stated ex ante risk tolerance. (Likely explanations are overconfidence in dealing with risk and treating the unlikely as impossible.) 
  • Many investors who were assessed as risk tolerant in 2007 and assigned portfolios heavy in equities dumped their equities in 2008 and 2009. Some fired their advisers.
  • When advisers were provided a hypothetical client situation, including a completed RTQ, the resulting recommendations showed remarkably wide variation, suggesting that investor RTQ profiles have less impact than one would expect: Investor-specific effects (such as risk tolerance) accounted for less than 12 percent of the variation in risky share (i.e., the amount of equity risk taken by investors in their portfolios). Adviser-specific effects accounted for 22 percent, leaving the majority of the variation unexplained.
  • Return expectations are a significant predictor of risk-taking decisions for both investors and advisers—individuals’ risk attitudes may be relatively stable, even in periods of volatile market conditions. Instead, it could be the individuals’ subjective expectation of risk and return that changes and thereby impacts their risk-taking.
  • Most advisers invested their own money similarly to what they recommended to their clients. Thus, advisers’ beliefs dictated not only their own investment choices but also the advice they provided to clients. And advisers’ return expectations were a statistically significant predictor of their risk-taking decisions.
  • Female investors typically take less risk than male investors. (This could be explained by men tending to be more overconfident than women.)
  • High-net-worth investors engaged in higher risk-taking. (They do have more ability to take risk, but their marginal utility of wealth is less.) 
  • Marital status was statistically significant — single investors engaged in more risk-taking than married investors.
  • The level of education of the adviser was positively correlated with risk-taking—those with more education took more risk. 
  • Those who had planned for retirement accumulated three times as much wealth as those who did not (which is why the saying that “those who fail to plan are planning to fail” is a cliché).  
  • Past positive (negative) investment experiences result in higher (lower) future stock market participation.

The evidence demonstrates that advisers need to do a better job of understanding their clients’ susceptibility to various behavioral biases. Investors are best served when advisers identify their clients’ overconfidence, anchoring tendency, propensity for maximising versus satisficing, susceptibility to recency bias and herd behavior. With that said, since advisers are also humans, they are likely to be affected by the same behavioral biases, notwithstanding their training and experience. The typical RTQ does not address these issues. 

The bottom line is that investors and advisers alike need to know that a full discovery process (as described in my book, Your Complete Guide to a Successful and Secure Retirement, which often includes sensitive personal information, is in their best interests. The discovery process should begin with “Life Discovery,” which includes four steps:

  1. Exploring life areas.
  2. Identifying vision and values.
  3. Articulating and prioritising goals.
  4. Addressing and overcoming concerns.

Having completed that part of the process, proceed to financial discovery, the more quantitative elements of your retirement plan:

  1. Financial assets and liabilities.
  2. Income.
  3. Advisers — accounting and tax, legal, insurance and investment. 
  4. Process you want to establish and follow.

As Sivarajan and De Bruijn explained: “A doctor, lawyer, or tax accountant cannot be expected to add value for their client without full discovery — and no patient or client would expect otherwise. A similar awareness is needed in the investment industry.”


Important Disclosure: The information contained in this article is for educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. The analysis contained in this article is based upon third party information available at the time which may become outdated or otherwise superseded at any time without notice. Certain third-party information is based upon is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party websites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. The opinions expressed by featured authors are their own and may not accurately reflect those of the Buckingham Strategic Wealth®, Buckingham Strategic Partners® (collectively Buckingham Wealth Partners). 


LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing.



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Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.


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