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Risk Tolerance Questions to Best Determine Client Portfolio Allocation Preferences

Journal of Financial Planning 25, 5: 36-44, 2012

9 Pages Posted: 21 Jun 2012 Last revised: 20 Apr 2015

Michael A. Guillemette

Texas Tech University - Department of Personal Financial Planning

Michael S. Finke

The American College

John Gilliam

Texas Tech University

Date Written: May 1, 2012

Abstract

The literature on risk tolerance overwhelmingly justifies the use of questionnaires based on validity and reliability or psychometric testing, but there has been little research examining the relation between questions and actual investor portfolio behavior. This study examines risk tolerance questions based on economic theory, prospect theory, and client self-assessment to determine the extent to which they explain variation in portfolio allocation preference and recent investment changes. We conclude that risk tolerance questions based on loss aversion and self-assessment should be used when determining the portfolio allocation of clients. While questions based on economic theory should theoretically be the best measure of a client’s portfolio allocation preference, the results of this study indicate that these questions are not very useful when both loss aversion and self-assessment questions are included in a risk tolerance questionnaire. Financial planners should begin to reassess the risk tolerance level of their clients around age 60, as there is evidence that risk tolerance declines later in life because of cognitive decline.

Keywords: risk tolerance, portfolio allocation, portfolio choice

JEL Classification: G11, D81, E62

Suggested Citation

Guillemette, Michael A. and Finke, Michael S. and Gilliam, John, Risk Tolerance Questions to Best Determine Client Portfolio Allocation Preferences (May 1, 2012). Journal of Financial Planning 25, 5: 36-44, 2012. Available at SSRN: https://ssrn.com/abstract=2088998

Michael A. Guillemette (Contact Author)

Texas Tech University - Department of Personal Financial Planning ( email )

1301 Akron Ave, HS-260
Box 41210
Lubbock, TX 79409-1210
United States

Michael S. Finke

The American College ( email )

Bryn Mawr, PA 19010
United States

John Gilliam

Texas Tech University ( email )

2500 Broadway
Lubbock, TX 79409
United States

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