Effects of Behavioral Factors on Adviser-Client Interactions

A successful client-adviser relationship is characterized by the planning, construction, and selection of the most optimal portfolio for the client. This involves staying the course, bolstered by solid communication between both parties. The first logical step is to have the client fill out a risk tolerance questionnaire.

Four traits of successful client-adviser relationships:

1. The adviser understands the investment goals of the client.
2. The adviser maintains a consistent approach.
3. The adviser meets the client’s expectations.
4. Both parties benefit from the relationship.

Risk Tolerance Questionnaires

During the initial stages of a client-adviser relationship, the adviser should administer a risk tolerance questionnaire. The adviser should use the questionnaire to assess the client’s attitude toward risk. Further, it is recommended that this questionnaire be re-administered annually during an IPS update.

While not a perfect solution, risk tolerance questionnaires represent a reasonable first attempt to get to know a client. Advisers should be aware of the following challenges associated with administering and using these questionnaires:

• Emotional biases – While questionnaires are helpful in establishing cognitive biases, they often do not capture emotional biases. Clients may not want to admit that they lack the self-control to save for the future. 
• Framing – Clients may interpret and answer the same question differently, even as a result of minor wording or syntactic changes.
• Inconsistent answers – Consistent with behavioral finance, clients’ answers may vary significantly depending on the context in which the questionnaire is fielded. This is why it is advisable for advisers to administer the assessments annually at the IPS update.

Question

Which of the following is most likely to be accurately captured by a risk-tolerance questionnaire?

1. Framing bias.
2. Behavioral biases.
3. Cognitive biases.

Solution

The correct answer is C:

Traditional risk tolerance questionnaires are more appropriate for institutional investors than individuals since they employ a cognitive approach when investing. It is noteworthy that the cognitive approach gives a better understanding of risk and returns.

A is incorrect: Framing bias would potentially affect how a risk tolerance questionnaire is answered.

B is incorrect: Behavioral biases are less likely to pop up on risk-tolerance questionnaires since they are more emotional and do not lend themselves to qualitative assessment. 

Reading 2: Behavioral Finance and Investment Processes

LOS 2 (b) Discuss how behavioral factors affect adviser–client interactions