4/12/2010. FinaMetrica Pty Limited FinaMetrica Pty Limited 2010

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differs from another. Four Types Physical, social, ethical and financial.

1 Nature Characteristics Role in Planning Assessment Advisers Estimates Latest Research Psychological Trait A relatively enduring way one individual differs from another. Four Types Physical, social, ethical and financial. Consistent behaviour within type but not across type. No sub-types within financial. 1

2 Tolerance Too Little Low Too Much High Definition* The extent to which an individual would normally choose to risk experiencing a less favourable outcome in the pursuit of a more favourable outcome. * ISO Personal Financial Planning Standards Mean = 50 SD = 10 2

3 Mean SD Women Men Scale: Mean 50, SD 10 Wife vs. Husband Probability Greater 34.2% Greater by % Less by % Within % 3

4 Age Mean SD Scale: Mean 50, SD vs. 35 Probability Greater 31.7% Greater by % Less by % Within % Income, wealth, education. Married, dependants Genetics Neuroscience Behavioural Finance Personality Models (Big 5 (Big 5 - OCEAN) Openness, Conscientiousness, Extraversion, Agreeableness, Neuroticism Overconfidence Locus of Control 4

5 FS Professionals FS Students Clients Public Increasing Tolerance Increasing Tolerance FS Professionals Self-Employed FS Students Clients Public Public Servants Does financial education influence retirement savings? Unisuper, 2006 How much risk you prefer to take. How much risk you can afford to take. How much risk you need to take. 5

6 1. Assess risk required, risk capacity and risk tolerance. 2. Identify mismatches, explain risks and assist with trade-off decisions. 3. Obtain your client s properly informed commitment. Bill and Suzie need a growth portfolio (70% stocks) to achieve their goals, but Bill s risk tolerance indicates a preference for a conservative portfolio (40% stocks) and Suzie s suggests a balanced portfolio (60% stocks). Assess Client s Tolerance Assess Partner s Tolerance 6

7 Evaluate Goals Evaluate Financial Resources Calculate (Return) Required Make Trade-Off Decisions Required vs. Capacity Too High OK B Ease goals Increase resources A B Required vs. Tolerance Too High Make Trade-Off Decisions Recalculate Required OK (Re)explain Ease goals Increase resources Take more risk Commitment 1. Assess risk required, risk capacity and risk tolerance. 2. Identify mismatches, explain risks and assist with trade-off decisions. 3. Obtain your client s properly informed commitment. 7

8 What s your risk tolerance? Uh? Interview or test? Validity, reliability and accuracy. Test development and evaluation. Pool of Questions Sample Questionnaire Useability Trials Understandable and answerable? Norming Trials Statistical Analysis Valid, reliable and accurate? 8

9 8-10 questions: goals, time horizon, investment experience, return expectations, risk capacity, risk tolerance, etc. Bad questions are common. Trade-off decisions are made opaquely on a third party s values. Insights from Psychology and Psychometrics on Measuring Tolerance Journal of Financial Planning, April % 80% 60% 40% 70% 100% 50% 20% 0% 0% Least y Answers Most y Answers Douglas Rice PhD, Golden Gate University 9

10 Correlate with test scores at ~.4 Are less accurate than clients self- estimates Client self-estimates estimates are more accurate than adviser self-estimates. estimates. Adviser estimates - exhibit gender bias - over/underweight other demographics Mean = 50 SD = Estimated Group Actual Group 10

11 Error Size ( Groups) Individual Estimates Group 4 Assumption FinaMetrica Database 350,000 completed risk profiles from June 1999 Global Financial Crisis Survey 127 advisers and 452 clients completed surveys between December 2008 and June 2009 Nightly Business Report/Kiplinger s Personal Finance Survey 1957 respondents completed surveys between October 2009 and December 2009 People all have high risk tolerance when the market is going up - but when the market starts to crash, their risk tolerance suddenly goes down to zero. 11

12 What do you intend to do now? Hold on to all of my stock investments. 64% Sell off some stocks and re-invest in the stock market. 22% Sell off some stocks and re-invest outside the stock market. 9% Sell off some stocks and keep the money as cash. 5% Sell all my stocks and get out of the stock market entirely. 1% *GFC Survey, Dec 08 Jun 09: 452 clients of FinaMetrica subscribers What did you do with regard to your stock market investments in the 2008/9 market decline? I kept all my stocks. 50% I sold some of my stocks and reinvested in the stock market. 38% I sold some of my stocks and did not re-invest. 8% I sold most of my stocks and did not re-invest. 2% I sold all my stocks and did not re-invest. 1% ** NBR/Kiplinger Survey Oct Dec 09: 1957 respondents behaviour is a function of factors other than risk tolerance: goals perceived alternatives perceived risks perceived risk capacity A change in risk behaviour will be due to change in at least one of the factors. 12

13 100 Average Tolerance Australia United States United Kingdom Joseph Goetz PhD, University of Georgia 13

14 14 Months classified as Optimistic or Pessimistic. Demographically al for RTS Demographically adjusted risk tolerance scores analysed by month type. n = 66,943 Pessimistic month Optimistic month Consumer sentiment Residua Pessimistic Optimistic Lujer Santa Cruz, University of Southern Queensland AUS UK US Jan 07 Jul 07 Jan 08 Jul 08 Jan AUS UK US Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

15 Test: July 2003 to December 2007 Retest: August 2008 to July 2009 n = 2408 t Test 1st Test/Re test 1st Test: Jul '03 Dec '07 2nd Test: Aug '08 Jul ' Correlation.738 Decrease n= nd Test Test/Retest Difference Mean SD 8.06 Decreased % Decreased % Within % Increased % Increased % Increase behaviour is a function of factors other than risk tolerance: goals perceived alternatives perceived risks perceived risk capacity A change in risk behaviour will be due to change in at least one of the factors. 15

16 To what extent has the current stock market decline affected your view of stock market risk? No impact. 26% I now believe that the stock market is somewhat more risky. 41% considerably more risky. 27% enormously more risky. 6% *GFC Survey, Dec 08 - June 09: 452 clients How risky do you think the stock market is today compared with two years ago? Much riskier than two years ago. 8% Somewhat riskier than two years ago. 24% About the same. 38% Somewhat less risky than two years ago. 26% Much less risky than two years ago. 4% ** NBR/Kiplinger Survey Oct Dec 09: 1957 respondents Nature Characteristics Role in Planning Assessment Advisers Estimates t Latest Research geoff.davey@finametrica.com 16

Personal Financial Profiling

Personal Financial Profiling Introduction Many financial decisions are made in situations of uncertainty, and so risk is involved. Different people are comfortable with different levels of risk. Unlike,