Investment Risk Profiling. Guide for Financial Advisors 2

20 Questions

Which type of criterion validity provides evidence that questionnaire or test scores provide meaningful insight into future behavior?

Predictive validity

Which type of validity refers to how accurate a tool is in describing or predicting human trait factors, attitudes, or behavior?

Criterion validity

Which type of validity is based on the professional judgment of subject matter experts?

Content validity

Which type of question elicits risk tolerance outside the context of investment risk taking?

Questions that ask about risky activities

According to FINRA rules, a firm or financial advisor must have a reasonable basis to believe that a transaction or investment strategy involving recommended securities is suitable. What is one factor that may be considered when assessing an investor's investment profile?

All of the above

According to the Investment Industry Regulatory Organization of Canada, what must a financial advisor be able to demonstrate before developing an investment recommendation?

Both the investor's willingness and ability to take risks

According to Article 25 of the Markets in Financial Instruments Directive II in the European Union, what information must an investment firm obtain regarding the investor's investment objectives?

Knowledge and experience in the investment field

Which of the following is a factor to consider when evaluating a risk-tolerance questionnaire or test?

All of the above

Which of the following elements should generally not be included in a risk-tolerance questionnaire or test?

Time horizon and risk capacity

What type of risk-tolerance assessments are generally not developed in the same manner as psychologically derived questionnaires?

Revealed preference assessments

What is the purpose of the decision rules in interpreting an IRP?

To reconcile conflicting factors revealed by the IRP

When can higher risk-taking ability be discounted?

When the risk need and behavioral loss tolerance are lower

Which of the following is a key consideration when selecting a risk-tolerance measure?

The variety of questions and scenarios in the questionnaire

What is the purpose of a revealed preference test in the risk-profiling process?

To serve as a proxy for financial risk tolerance

What type of reliability estimate should a test developer provide for a revealed preference measure?

Cronbach's alpha based on test-retest data

What should be measured independently within the broader risk profile, according to the checklist for evaluating risk-tolerance measurement tools?

Objective factors and question weighting

Which of the following is an example of a revealed preference question?

Which annuity would you choose?

Which of the following is an example of a biased question?

How would you describe your preferred investment strategy?

Which of the following is an example of a complex language question?

How would you describe your preferred investment strategy?

Which of the following is an example of a double-barreled question?

Please agree or disagree with the following statement: I am financially knowledgeable and experienced.

Study Notes

Investment Risk Profiling: Simplifying the Process

Table 2 provides a scoring sheet to evaluate an investor's behavioral loss tolerance elements.
The scoring sheet includes questions on risk tolerance, preference for holding risky assets, knowledge about financial concepts, experience with investment products, and perception of stock market risk.
Scores for each element should be summed, and total scores range from 6 to 30.
The total score can be matched to behavioral loss tolerance categories: low (6-13), moderate (14-22), high (23-30).
The Investment Risk Profiling (IRP) informs portfolio recommendations by assessing risk need, risk-taking ability, and behavioral loss tolerance.
Conflicting factors in the IRP require the advisor's professional judgment to reconcile.
Decision rules guide the interpretation of the IRP, such as reconsidering goals and savings rates when risk need exceeds risk-taking ability.
Risk-taking ability can be discounted when risk need and behavioral loss tolerance are lower.
A lower risk need can be discounted when risk-taking ability and behavioral loss tolerance are higher.
Higher behavioral loss tolerance can be ignored when risk need and risk-taking ability are lower.
Low behavioral loss tolerance can never be ignored, but counseling and education can be used to encourage higher-risk portfolios.
A financial advisor should not recommend a portfolio allocation that exceeds an investor's risk-taking ability.

Summary: The current practice of using a single risk coefficient or data input is flawed. The IRP helps inform portfolio recommendations by assessing risk need, risk-taking ability, and behavioral loss tolerance. Financial advisors must use tools that fully inform professional judgment to increase the likelihood of achieving investor goals. Validity and reliability should be considered when choosing a risk-tolerance assessment tool.

Learn about investment risk profiling, behavioral loss tolerance categories, and how scores are used to inform portfolio recommendations. Discover decision rules and conflicting factors in the process, emphasizing the importance of a thorough assessment for achieving investor goals.

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