For years, the retirement industry has been trying to assess peoples’ investment risk tolerance using a variety of methods. However, these methods often have proven to be ineffective at assessing risk, and have instead both heightened investor anxiety and negatively impacted the usefulness of an advisor’s planning session. This is due in part to how these questionnaires are developed — they are heavily reliant on techniques based on mathematics, complicated data tables and investment jargon.
In research data, anxiety about retirement planning and savings behavior has emerged consistently as a key barrier to engagement. Specifically, we know from our research with DC participants that one’s self confidence and knowledge about financial topics contributes to their engagement and better decision-making behavior. The other significant factor that impacts engagement is trust — trust in oneself as well as the people and institutions participants are reliant on for investing and managing those investments.
When we combine these two factors (confidence and trust) that drive engagement, they become a powerful index that we call “financial courage.” Financial courage is directly linked to improved financial decision-making, including higher savings rates.
A big part of what we do at the National Association of Retirement Plan Participants (NARPP) is creating communications experiences that are based in behavioral finance and human-centered design. This is a unique, interdisciplinary approach that has proven extremely effective in building participant self-confidence and trust in the communicator. Using these same disciplines as a foundation, we set about designing a new way to measure risk tolerance. The goal was to create a questionnaire that would more accurately assess a person’s risk comfort zone through a more human-centered approach; that is, an approach that eliminates jargon, complicated math and other barriers to positive cognitive and behavioral change.
We were confident that we could build a better model for approximating one’s risk tolerance, but we were surprised to discover that a more accurate assessment of a participant’s risk tolerance actually increases their trust in their advisor. The result is not only a new behaviorally effective risk assessment tool, but — just as important — a new tool for increasing trust in the advisor or administrator of the tool.
The following is a case study of our field test using this new risk assessment tool.
Case Study: Redesigning Risk Assessment
- Questionnaire design: Warren Cormier, CBO, NARPP
- Project partners: Utah Retirement Systems (URS), Dimensional Fund Advisors
- Format: Online questionnaire (5 min.)
- Goal: Measure accuracy of assessment and impact
- Testing time: One year
- Number of participants: 3,500+
- Summary: By replacing typical risk assessment questions, which require a working understanding of financial jargon, personal investing acumen and math, with behaviorally based questions we’ve created a more personalized and accurate assessment of investing attitudes, courage and preferences. This has resulted in higher levels of trust with the advisor and deeper engagement with financial decision-making.
The questionnaire asks participants to consider how they would react to nine different hypothetical market scenarios. Imbedded in the scenarios are important behavioral concepts (such as prospect theory, hyperbolic discounting, loss aversion, endowment effect, etc.) that impact financial decisions affecting the participant’s retirement income resources, such as a pension, Social Security and defined contribution plans.
The online assessment was conducted prior to a retirement planning session with a URS retirement planning advisor. At the beginning of the in-person planning session, participants were told that the assessment indicates the type of investor they are, relative to their risk comfort level. Based on their risk profile, the advisor would make recommendations for their pension, Social Security, a model portfolio and/or a target date fund that has been mapped to their specific risk tolerance level.
In nearly all of more than 3,500 cases, participants have agreed with the assessment of their risk comfort level. And in those very few cases where participants did not feel the assessment was correct, all adjusted their self-assessment by one risk category up or down, but never more.
The fact that a very high percentage agree with the assessment is only part of the story. In addition to helping people identify their comfort zone and optimizing their risk/return algorithm, the questionnaire had a significant impact on the interactions between the advisor and the participant, according to the plan’s administrator.
Our testing partner explained that participants’ level of trust in the advisor increased significantly as a result of the assessment’s accuracy. This is due to the participant’s feelings that the advisor truly understands the participant, perhaps better than the participant understands him/herself.
Research on the antecedents of trust and engagement indicate that creating a sense of empathy is critical to building trust and confidence in an advisor’s competence, motives and the value of their advice. This consequently makes the participant much more receptive to recommendations.
The perceived accuracy of the assessment also serves to relax the participant, enhancing engagement with the advisor, allowing them to truly focus on the goal of session and not on the credibility or possible motives behind the advice they are getting. Participants “open up” and are willing to have a discussion that is far less guarded, revealing details to the advisor that are helpful in crafting their recommendations. The perceived accuracy also serves to create a sense of customization of the advice to their particular situation. As we know, nothing engages people more than a story that places them and their needs at the center of the plot.
Does the risk-assessment questionnaire accurately identify the participant’s comfort zone under any circumstances? Our pilot-testing partner believes it accurately describes the participant’s comfort zone in a high percentage of the circumstances they will face as retirement investors. Undoubtedly, the participants agree. But the more important effect was to enhance the quality and usefulness of the planning interaction.
Warren Cormier is the president and CEO of Boston Research Technologies and author of the DCP suite of satisfaction and loyalty studies. He also is cofounder of the Rand Behavioral Finance Forum, along with Dr. Shlomo Bernartzi. This column originally appeared in the most recent issue of NAPA Net the Magazine.