Actions speak louder than words, so why do traditional risk profiling surveys only take into account what investors are prepared to share and can easily articulate?
At present, Australia’s financial services industry assesses consumer risk tolerance through surveys where investors are asked to state their preferences to a range of questions and are then provided with a risk profile upon completion.
However, answering questions in this method through stated preferences is not always as simple as the end results advisers are provided with, which often take the form of a number on a scale.
This is the view of Professor Shachar Kariv, chief scientist of Capital Preferences and chair of the Department of Economics at the University of California Berkeley.
Kariv has spent his life studying the decision-making preferences of individuals and the science behind it, and knows that what investors tell advisers in the form of a traditional survey isn’t enough information to base a risk profile, or piece of financial advice on.
The problem with surveys, aside from their construction which is not underpinned by any mathematical certainty, is that often investors are not able to articulate their preferences in a precise way that fits within the response structure the survey is able to accommodate, he says.
The resulting frustration can then see investors rush through a survey to get it done as they don’t feel like they’re doing a good job with it and want to get it out of the way.
To illustrate this, Kariv gives the example of riding a bicycle, which many people would know how to do, but might not be able to explain.
“You will find the survey on this very annoying because you cannot articulate how you ride your bicycle,” Kariv says.
“So at a certain point, you’ll say ‘I’ll ride my bicycle and you’ll actually see how I ride it.’
“This is exactly the difference between the stated preferences method using a questionnaire or a survey, and our method.”
Kariv and his team have developed the Economic Fingerprint, a game which investors can play to determine their financial decision-making preferences and approaches to risk, loss and uncertainty.
The game uses revealed preferences, as opposed to stated, which means investors have to show their responses instead of telling them, across a range of scenarios that focus on the trade-off between risk and return.
“I will never ask you what your preferences are,” he says.
“Instead, I will give you in a game environment, decisions that involve trading off risk and return, and from how you actually trade off, or how you actually ride your bicycle, I will be able to understand your risk preferences.”
To discover your own Economic Fingerprint and find out how it can help your clients take the test here.
Written by Elizabeth Somerville, Content and Community Manager, evolution media group.
