Correlation Confound (Part 5)

Along with “diversification” and “pairs trading,”, “risk tolerance” can also be discussed in terms of advertising. How much product, in terms of AUM, has been sold by investment advisers (IA) purporting to use special care in recommending only what suits your unique situation, your goals, and your personal risk tolerance? 

Like correlation confound #1 where historical values change in the future, risk tolerance can also change.  How many investors prior to 2008 answered the questionnaire with 30% but started to experience rapid heartbeat, panic, and insomnia when their account was down only 10% during the last correction?

Psychological questionnaires are designed to ask enough questions to confirm responses and to avoid drawing conclusions based on fluke answers. I hope IA’s do the same. One multiple choice question isn’t good enough. Go into detail about a world with catastrophic headlines in the newspapers, blatant fear across Facebook, and dramatic shock and awe on the evening news. How would you feel in this scenario? What is your risk tolerance now?

Risk tolerance may not even be measurable and if this is the case, all mention about a “personal touch” employed to accurately assess it may reduce to deceptive marketing.  An online search turned up this:

> I say this from several decades experience in advising
> thousands of clients. Psychological risk tolerance is not
> a worthwhile a priori input. People routinely falsely report
> it or can’t really self-assess. Further, it changes over
> time, due to various factors, including the client’s age
> and other non-portfolio wealth factors.

Maybe risk tolerance should be taken out of the equation altogether?

At the very least, I think we should all be aware that “risk tolerance” is another buzzword often used by IA’s as an opportunity to express deep-rooted care and concern for our financial well-being.

I just hope it’s not an unquantifiable illusion—a manifestation of optionScam.com.