| This paper looks at the risk tolerance questionnaires that are currently in use to determine if there is significant variance between them which, when administered, could result in an inappropriate portfolio for an individual investor. As risk tolerance is often the sole determinant of asset allocation and asset allocation is a crucial factor in wealth accumulation, implications of measurement error are profound.; This paper clearly shows that investors are not being well served by the existing risk tolerance questionnaires. It's possible that the same investor, on the same day, in the same frame of mind, could walk into one firm and be seen one way and into another and be seen differently; all based on the risk tolerance questionnaire used by the firm. The results show that risk tolerance measurement varies significantly with only some construct uniformity among instruments. Further, the results offer empirical evidence of significant differences in the definition, approach, and measurement of risk tolerance, giving rise to considerable concern over reliability and validity.; This investigation of the variance in psychometric risk tolerance measurement instruments used a sample of 131 risk tolerance questionnaires from four types of organizations; the investment firm, the academic, the periodical, and the individual advisor. Data was developed on the overall instrument such as number of questions asked, type of firm, and the resulting portfolios from various answer scenarios. Further, data was developed on each individual question; i.e., the element of the risk tolerance construct that the question was attempting to measure and the specific way the question was trying to measure it.; Once the wide variance was established, a new model of risk tolerance measurement was developed. This new, more holistic, model blends the financial and economic concerns of the individual investor with their psychological ability, aversion and desire for risk and return. It is hoped that this paper provides a direction for further work in this under-emphasized area of research, leading to a more uniform theory of risk tolerance measurement and an increase in the quality of financial advice given to individual investors. |
