When it comes to Investment Risk- Are you Country or are you Rock? Part 2

When it comes to Investment Risk- Are you Country or are you Rock? Part 2

facebooktwitterlinkedinby featherDon't steal my savingsThe Financial  Adviser’s Problem

There are two reasons why a financial  adviser needs to measure an investor’s risk preferences. These have to do with the two ways that financial advisers add value for investors.

The first way an adviser adds value is to act as the agent for the investor, faithfully carrying out the investor’s wishes. Many investors don’t have the time or the proper tools to manage a portfolio by themselves,  so they delegate the job to an adviser. In order to carry out the investor’s wishes, an adviser must have an understanding of the investor’s risk preferences.

The second way an adviser adds value is to improve the investor’s decisions. Investors may be financially unsophisticated, or subject to certain biases, as documented in Loos et al.  (2014). By adding knowledge and subtracting emotion, advisers can improve investors’ portfolio choices.

More subtly, an investor may not be able to implement her own risk preferences when choosing a portfolio. An investor who avoids the stock market is avoiding both the risk of the market and the uncertainty of investing in an asset whose risk she does  not fully  understand.  The “money doctor”  hypothesis of Gennaioli, Shleifer, and Vishny (2015) states that trusted advisers may act to reassure investors that there is no hidden, unobserved source of risk, allowing investors to take on more risk (and thus earn higher returns) than they would on their own.

The investor’s inability  to perfectly choose her own portfolio has two very important implications for financial advisers. First, it increases the importance of advisers, since they must find a portfolio that pleases an investor  more than the one the investor would choose on his own. Second, it makes the adviser’s task more difficult,  since the adviser cannot perfectly infer the investor’s preferences from his past decisions. The adviser therefore  needs tools to better gauge the investor’s preferences. Financial advisers can measure investors’ preferences informally, through casual conversation, or formally, as with the quiz-type PMMs that have become more common in recent years. It stands to reason that more accurate and directly applicable measurements of financial risk preferences would allow advisers to better serve investors.

Want to see if you are Country or Rock? Take our questionnaire and see for your self.

Just click on home and scroll to the bottom of the page and click on the “What Your Risk Number? button.

 

 

 

 

 

 

 

1-Application of Preference Measurement: The Case of Riskalyze

By: Fangfei Dong; David Eil, PhD; Ethan Pew, PhD; and Noah Smith, PhD

Written by Jaimie Blackman

Jaimie Blackman

Jaimie Blackman — a former music educator & retailer— is a Certified Wealth Strategist & Succession Planner. Jaimie helps business owners maximize the value of their company through education & coaching. He is a frequent speaker at the National Association of Music Merchants, (NAMM) Idea Center and has spoken at Yamaha’s succession advantage.

As a financial literacy educator he has taught at New York University and has lectured at the 92nd Street Y, Marymount Manhattan College and CUNY.

His column is published in The Music & Sound Retailer and contributes to NAMM U online, as well as other industry trade magazines.

Jaimie is CEO of Jaimie Blackman & Company, President of BH Wealth Management, and Creator of MoneyCapsules® and the Sound of Money®.

To register for Jaimie’s live webinars, or to subscribe to his podcasts, visit jaimieblackman.com.

The purpose of this post is to educate. Our content should not be construed as advice. If legal, tax or other advice is required by the readers, professional advice should be sought.

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