Investment Risk Profiling: Lessons from Psychology

Abstract

The risk profiling process is one of the most under-utilised assets the financial planning profession has at its disposal. This paper presents a novel approach to risk profiling, which is based on the application of the psychology literature to develop an empirical risk profiling system. This paper provides a theoretical foundation for considering the risk profiling system by applying the literature from self-control, optimism, financial literacy, and risk tolerance, to a risk profiling system. This paper discusses how understanding client levels of self-control can impact ‘stickability’ to a financial plan, and how prior knowledge of optimism, financial literacy and risk tolerance can enable financial planners to have more engaging discussions and design more tailored financial plans for their clients. This is the first stage of the research project, with the second stage the development and testing of a risk profiling system based on the theory within this paper.