Know your Risk

Security to make your own decisions while lowering your chance of loss. Is it too much to ask?

This is not revolutionary thought. It just makes good sense.

Where do you stand on the issue of risk?

Know your riskPersonal Financial Power starts with what we believe is the most important move you need to make in your financial life when it comes to investing your money.

Understand RISK

Important?? You bet it is.

If you don’t know your baseline (also known as your risk tolerance), you can be whipsawed mercilessly by events or by people telling you what you should do about your finances.

Here is the real story: you need to know yourself – especially in how much risk you can tolerate when it comes to your finances. You need to know how risk surveys are used and which ones are reliable. But most of all, you need to take a survey that measures the risk you are willing to take no matter what is going on in the world.

Know where you stand
PPL MOVE ONE – KNOW WHERE YOU STAND
  • We suggest you enhance your Personal Financial Power by KNOWING YOUR RISK. WHY?

Studies show your ability to handle adverse financial circumstances typically does not change, but the financial environment is always changing. People without an understanding of their true personal risk tolerance look as though they lack discipline. Is that really the case? We don’t think so. It is not because individuals lack discipline. The problem may result from lack of self-knowledge of how much risk they can tolerate.

One of the most respected studies on investor behavior is the annual Dalbar study. Below is the 2015 study. Are you like the average investor who severely underperforms in your investment accounts because you make the wrong moves? Here are the sad facts from the latest analysis of investor behavior showing investor returns for 1, 10, 20 and 30 years as of 12-31-2015.

Annualized

1 Source: “Quantitative Analysis of Investor Behavior, 2016,” DALBAR, Inc. www.dalbar.com

If your results reflect the typical investor’s performance, it may mean you just don’t know your tolerance for swings in markets or how news about the economy affects you until it is too late. You may be making moves in your investment accounts at the absolute worst times.

To give you the best odds to make a difference in your own life we suggest you start here: know yourself and your risk tolerance.

Are you like the majority of people who worry whether they are doing the right thing? If markets are positive, do you jump into increasingly riskier positions because you don’t want to miss out? Doing so may create too much risk for you.

Then, when the inevitable bad market environment starts to rear its ugly head, you think maybe it will come back. You don’t want to lose out. Inevitably, like everyone else, you freak out and lose money because you jump out at the exact wrong time. What happens is instead of buying low and selling high, your risk constraints are violated so you buy high and sell low.

The research shows that the majority of people are terrible at determining when to be in or out of the markets. The average investor does so poorly compared to the markets because they don’t know how to be true to their own limits. The problem is that they don’t know what they are nor have they been educated to invest according to their actual risk tolerance.

  • All risk tolerance tools are not the same – what bias may be lurking in the one you are relying on? Learn more about tools measuring risk.

Knowing your own risk tolerance is very important. Having realized that, the dilemma then becomes ensuring that your tool does not give you a skewed reading of the risk you can stand.  It’s imperative that you know your risk tolerance tool is highly reliable. Since a large part of having personal financial power is knowing yourself and the risk you can accept, we knew it was important to provide a highly scientific tool to people we work with.

We found hundreds of different risk tolerance tools in our search for one with high reliability.  Many of these are provided by companies that sell various investment products or services, which may cause concern that results could have a bias toward the product or service being offered.

Next, the methods used by independent risk measurement tools that purport to measure risk with highly accurate reliability may be suspect. Research based on the results of a survey of more than 2,500 participants at the Santa Clara University Department of Finance showed that typical risk questionnaires aimed at helping advisors guide investors are deficient in five ways:

  1. Each investor has a multitude of risk tolerances, one for each goal and its mental account. Probes for one global risk tolerance miss that multitude.
  2. The links between answers to questions in risk questionnaires and recommended portfolio allocations are governed by opaque rules of thumb rather than by transparent theory.
  3. Investor’s risk tolerance varies by circumstances and associated emotions. Failure to account for such variations biases assessments of risk tolerance.
  4. Risk tolerance varies when assessed in foresight or hindsight. Hindsight amplifies regret. Investors with high propensity for hindsight and regret might claim, in hindsight, that advisors have overstated their risk tolerance.
  5. Investor propensities other than risk tolerance and regret matter to advisors as they guide investors.

Carrie H. Pan,  Meir Statman, 3-10-2012 Questionnaires of Risk Tolerance, Regret, Overconfidence, and Other Investor Propensities, SCU Leavey School of Business Research Paper No. 10-05

Similar research that measured the use of scientifically reliable programs such as surveys built on psychometric research combining psychology and statistical analysis showed these types of tools have high reliability.   There are verified techniques that improve the measurement of some subjective or emotional factors like risk tolerance or loss aversion, but research shows that less than 20% of all advisors use these types of programs.[1]

[1] Current practices for Risk Profiling in Canada and Review of Global Best Practices, Prepared for the Investor Advisory Panel of the Ontario Securities,  Commission Lessons from the Financial Crisis: We’ve Been Here Before, Fox Business, By: Dave Huber

  • Finding a reliable and scientifically based risk management tool is imperative. We provide a tool built on psychometric research that combines psychology and statistical analysis. Read the research.

The Survey and Questions

Because of all these issues, we want to ensure that people we work with receive unbiased and accurate information. The Risk Tolerance survey we choose to supply to people we work with is provided after much thought on our part.

We vetted several companies – looking for risk tolerance programs with unbiased questions and results, a clearly superior risk tolerance service and with ease of use.

The survey we chose uses just 20 questions. They’ve been developed based on compliance requirements, academic research, interviews with financial advisors and tests involving the general public. The academic basis comes from 12 sources, ranging from books to white papers to published journal articles. However, three texts in particular formed the foundation of the questions.

  • Michael J. Rozkowski’s “The Survey of Financial Risk Tolerance” (1994). Developed at The American College in Pennsylvania, USA, this highly regarded study recommended by the Institute of Certified Financial Planners is an authoritative guide to assist financial advisers in uncovering their clients’ propensity for risk.
  • Research was also developed based on Dr. John Grable and Dr. Ruth H. Lytton’s “Financial risk tolerance revisited: the development of a risk assessment instrument” (1999). Regarded highly amongst academics and risk professionals, this paper discusses the issues related to creating risk tolerance assessment tools.
  • Finally, this company developed questions based on Alistair Byrne and David Blake’s “Investment risk and financial advice” (2012), which was written for Vanguard in constructing a risk-profiling tool.

Beyond academic research, they gathered feedback on questions from dozens of financial advisors who have a combination of hundreds of years of experience in the industry. They were able to give qualitative advice on the risk questions, ensuring they could meet the demands of a wide-ranging client base. As a result of this process, thirteen of their original 21 questions were edited and one was deleted.

The survey we selected for our subscribers has been subjected to statistical testing and evaluation to ensure high validity and reliability. Further details of the statistical method are described under Testing the Questionnaire Approach in the fourth section of this page..

This risk assessment, along with other information about you, can then be used to help you in your work with financial professionals or in use with the decisions you make to take advantage of low cost or flat fee management.

The questions were heavily researched and designed to be easily understood to ensure reliable results.

  • Completing a highly reliable scientifically based risk tolerance measurement survey.

We suggest completion of a Risk Tolerance survey specifically chosen for our clients. The following information, from the survey company, shows you how the survey works. 

Overview

After researching the range of possible ways to develop our product, we decided to use a psychometric scale scoring system.

We wanted our rating scale response options to be clear, discrete and consistent.  This would result in a clear questionnaire that is valid, reliable, and most importantly produces actionable reports.  The range of response options you will be using when taking your risk survey are:

  • Strongly AgreeOverview
  • Agree
  • Somewhat Agree
  • Undecided
  • Somewhat disagree
  • Disagree
  • Strongly Disagree

 

How it’s Scored

Each question in the risk assessment must be answered. In general, answers for every question are scored from 0 to 6.  Generally speaking, 0 represents the answer with least risk and the 6 represents the answer with the lowest WHAT – is this different from risk?.  All questions are used in final scoring and have an equal weight, except Question 20.  Questions 14 and 15 have possible scores of 0, 3 and 6 because they have three possible answers instead of seven.  Therefore, with a total of 20 questions (19 of which impact scoring), the minimum possible score is 0 and the maximum score is 114.

We then score someone relative to sample data for the US population.  Below are the results from the sample.

  • Possible Score Range 0-114
  • Average score – 59
  • Median score – 59
  • Lowest score – 17
  • Highest score – 95

To make the data easier to understand, the final score is adjusted to fit a 0 to 100 scale, with 50 is the average.

Finally, your final score is one of five broad risk categories:

  • Low risk – 0-34,
  • Low-medium risk – 35-43,
  • Medium risk – 44-55,
  • Medium-high risk – 56-64,
  • High risk –  65 or above.

We have more research and great information regarding the tools that we provide to our clients but you need to ask.

We also invite you to learn about the second empowering step we recommend for clients Easy Financial Organization

Risk Tolerance – it is important to know your score 

easily understandableWe provide to you one of the most well researched and scientific web-based risk tolerance programs built to assess an individual’s financial tolerance.

Risk is defined as the possibility of a negative outcome. we ask clients to answer a total of 20 questions, which must be completed to get a final score.

The results calculated from your answers to these 20 questions scores your individual risk tolerance relative to a sample of the US population. The result is a risk tolerance score from 0-100, tailored to you, with lower scores demonstrating low-risk qualities and higher scores demonstrating high-risk qualities.

This risk assessment, along with other information about you, can then be used to help you regarding your work with financial professionals or in using the Wealth Net Advisor’s program which is offered as part of your PFP subscription.

The questions were heavily researched and designed to be easily understood which ensuring reliable results.

The Survey and Questions

The Risk Tolerance survey we chose for our clients is provided to you after much thought on our part as to what was needed to insure you receive unbiased and accurate information.

We vetted several companies – looking for risk tolerance programs which provided with questions and results which were unbiased, reflected the highest state of the art risk tolerance service and was easy to use.

The company we chose for our subscribers uses 20 questions which have been developed based on compliance requirements, academic research, interviews with financial advisors and tests involving the general public. The academic basis comes from 12 sources, ranging from books to white papers to published journal articles. However, three texts in particular formed the foundation of the questions.
Firstly, Dr. Michael J. Rozkowski’s “The Survey of Financial Risk Tolerance” (1994). Developed at The American College in Pennsylvania, USA, this highly regarded study recommended by the Institute of Certified Financial Planners is an authoritative guide to assist financial advisers in uncovering their clients’ propensity for risk. Research was also developed based on Dr. John Grable and Dr. Ruth H. Lytton’s “Financial risk tolerance revisited: the development of a risk assessment instrument” (1999). Regarded highly amongst academics and risk professionals, this paper discusses the issues related to creating risk tolerance assessment tools. Finally, this company developed our questions based on Alistair Byrne and David Blake’s “Investment risk and financial advice” (2012), which was written for Vanguard in constructing a risk-profiling tool.
Beyond academic research, they gathered feedback on questions from dozens of financial advisors who have a combination of hundreds of years of experience in the industry. They were able to give qualitative advice on the risk questions, ensuring they could meet the demands of a wide-ranging client base. As a result of this process, thirteen of their original 21 questions were edited and one was deleted.
The survey we determined best for our subscribers has also been subjected to statistical testing and evaluation to ensure high validity and reliability. Further details of the statistical method are described below under Testing Our Questionnaire Approach.
Below is information from the company which demonstrates the care and research used to insure the highest quality is offered to our clients – best to hear it directly from them.

Information from your Risk Tolerance Survey provider.

After researching the range of possible ways to develop our product, we decided to use a psychometric rating scale scoring system. This is so we could compare the results of different individuals and develop a statistically rigorous and objective scoring system. We wanted our rating scale response options (i.e. the answers) to be clear, discrete and consistent. This would result in a clear questionnaire that is valid, reliable, and most importantly produces actionable reports. To meet these objectives, we decided to employ a Likert-type scale, which is a popular response scale used in psychometrics (the study of measurement statistics in psychology). The Likert scale was developed by Dr. Rensis Likert at Columbia University in New York.
An item (i.e. a question) based on Likert scaling gives individuals seven options to solicit information about beliefs, attitudes or feelings. Likert-type scaling is probably familiar to you. The range of response options we have chosen are:
• Strongly Agree
• Agree
• Somewhat Agree
• Undecided
• Somewhat Disagree
• Disagree
• Strongly Disagree
Psychologists favour Likert scaling for a number of reasons. Firstly, they value its balance between positive and negative responses, which works to ensure answers are not biased because of the available options. Secondly, the fact that respondents cannot simply answer “yes” or “no” works to ensure a spread of opinion (i.e., increases response variability) and better captures the respondents’ true feelings. Finally, the fact that the results can be easily analysed means we can come to quicker conclusions on a respondent’s overall attitude. These are the same reasons why we have chosen the Likert scale for our answers; so we can reduce bias in the results, truly reflect an individual’s opinion, and come to a conclusion quickly and reliably.
The Scoring
Each question in our assessment must be answered. Each answer for every question is scored from 0 to 6 (except questions 14, 15 and 20 explained below). Generally speaking, 0 represents the answer with least risk and 6 represents the answer with most risk. However, in some questions this is reversed, with 0 being the highest risk and 6 the lowest. Besides question 20, all questions are used in final scoring and have an equal weight. Questions 14 and 15 have possible scores of 0, 3 and 6 because they have three possible answers instead of seven. Therefore, with a total of 20 questions (19 of which impact the scoring) the minimum possible score is 0 and the maximum score is 114.
We then score someone relative to sample data for the US population. Below are the results from the sample.
• Possible Score Range 0-114
• Average score – 59
• Median score – 59
• Lowest score – 17
• Highest score – 95
In order to make the data easier to understand, we adjust the final score to fit on to a 0 to 100 scale, where 50 is the average. Finally, we map someone’s final score to one of five broad risk categories: Low risk for those who score 0-34, Low-medium risk for those who score 35-43, Medium risk for those who score 44-55, Medium-high risk for those who score 56-64, and finally high risk for those who scored 65 or above.
Testing Our Questionnaire Approach
In order to ensure our approach to the questionnaire was fit for use, we tested the first model to ensure it was valid and reliable. A valid questionnaire asks the right questions to discover the most accurate traits, in this case someone’s risk profile. A reliable questionnaire gives an accurate final result that is consistent across different groups. To ensure the validity and reliability of Pocket Risk, it was tested on a sample of real people. We commissioned Ask Your Target Market to survey a sample of the US population with our questionnaire. These individuals were representative of the US population and included a mix of males and females both young and old.
To ensure the validity of our questionnaire model we conducted a statistical analysis of our questions using Exploratory Factor Analysis (EFA). An EFA will produce two important pieces of information: which questions group together to describe financial risk, and how strongly each item relates to financial risk. In our case, it seeks to assess whether each question validly measures financial risk and not some other unrelated topic. But how do we know if these questions/items are accurately depicting risk?
To address this question, we looked at two important elements for designing a group of items, which describe risk. The first part involved defining risk (see above) and writing questions to target risk; the second piece entails performing an EFA on the items to ensure that they do in fact “group” together and describe risk. The concept of “grouping” is important because the more items that accurately depict a construct, the more confident we are that risk is being assessed accurately. The statistical results of the EFA indicated that our items accurately measured the constructs of financial risk tolerance and that they work together to produce an overall measure of financial risk tolerance.
The reliability of a questionnaire measures how consistent the questions are from person to person in measuring financial risk, with scores ranging from 0 to 1. Reliability can be calculated using Cronbach’s alpha, a statistic developed by Dr. Lee J. Cronbach and commonly used in psychometrics to measure reliability. Scores above 0.8 are considered highly reliable. Following the survey commissioned by Ask Your Target Market, our questionnaire model scored 0.82, validating our questionnaire’s reliability.
Therefore, we can conclude that our financial risk profiling methodology is both valid and reliable.