Investing State Versus Trait

If you have watched a fintech product demo that includes anything remotely related to financial psychology, you might hear the word “personality” thrown around a lot. For example, I heard one very confident salesperson recently refer to his platform as measuring “investor personality” when the tech was measuring the client’s current feelings about investing.

Personality characteristics predict a wide range of future outcomes regarding human behavior. The Big Five (or OCEAN) model of personality has been used to help predict life-related outcomes, from how we make spending decisions to how we perform at work. If you look at the Client Psychology book from the CFP Board, you’ll see in Chapter 8 that a client’s personality brings a host of implications for the way they make financial decisions. (Note that this chapter gives you insights into how to use this knowledge to help your clients succeed!).

I’m confused by those in the financial services community who do not harness the power of personality-based risk tolerance tests (ours or other reputable tests out there!) or their less efficient cousin, structured interviews, to predict client behavior. Measuring client personality can give firms an advantage in anticipating what their clients might do in a market like the one we find ourselves in today.

Mistrust of RTQs? Blame Investing State Versus Trait Confusion

My theory now is that there has been widespread confusion related to “testing” in financial services because of the following:

  1. Most financial professionals are familiar only with “risk tolerance questionnaires” (RTQs).
  2. Most RTQs are a mish-mash of different questions and have few psychometric properties (e.g., evidence of reliability and validity).
  3. Therefore, they do not predict client behavior.
  4. Therefore, financial professionals do not trust RTQs.

But lately, I’m finding myself considering a different theory. It goes something like this:

  1. Most financial professionals are familiar only with “risk tolerance questionnaires” (RTQs).
  2. The most popular RTQs are revealed preferences tests, measuring clients’ temporary investing-related “states” and, therefore,
  3. The most popular RTQs can’t predict client behavior, so
  4. Financial professionals do not trust RTQs.

To understand this a bit more, let’s take a look at two different ways of describing our clients when it comes to investing:

  • state: a temporary way of feeling, behaving, or thinking (e.g., emotions, perceptions, feelings). Example: My client is worried about the stock market right now. She has a low risk mood score.
  • trait: an enduring characteristic that dictates a client’s behavior in different situations. Example: My client is high on volatility composure. Generally, she is less fearful and anxious than most clients.

The Temporary Investing State & Revealed Preferences

Many fintech tools in the risk tolerance and behavioral assessment spaces measure a client’s temporary state regarding investing. For example, suppose your RTQ asks clients how they want to invest right now, what their preference for risk today looks like, or which type of income gamble they want to take. If so, the chances are you are using a measure of a client’s investing-related state (or something highly correlated with market mood). The most popular risk tolerance tests with single numbers measure a client’s revealed preferences, which are temporary and based on what’s happening in the markets. This is part of why they are less than ideal for predicting future behavior.

We want to be aware of how our clients are currently feeling about the world, the economy, and their financial situation. It is essential to understand a client’s current emotions related to investing. That can help us shape how we communicate with them and provide ways to demonstrate empathy. For example, we’ve added a “risk perceptions” scale akin to measuring revealed preferences to our Investor Profile RTQ precisely to help advisors communicate plans effectively given a client’s state.

Why We Need To Know A Client’s Traits

But, a client’s emotional reaction, or state, is not a stable measure of personality that can predict future behavior. But, again, the most commonly used RTQs measure a client’s state. It is not in the client’s best interest to design or amend long-term financial plans and investment strategies based on current feelings, perceptions, and emotions.

On the other hand, our personalities are generally stable. They are our traits or more enduring components of who we are. Personality is made up of a combination of characteristics that are both innate (the nature part) and learned (the nurture or experience part). While life events and interventions like coaching can alter our personalities to some extent, our personalities are relatively consistent throughout our lives.

Since our personalities are generally stable and do not shift and change frequently, we can use personality tests, measures of stable traits, to anticipate what we might do in the future. You can read more about this in a piece we wrote for on psychometrics.

The state versus traits debate is not clearly articulated in the advisortech world yet, or in financial services for that matter. Instead, the distinction still resides in the halls of academia. Given the nature of the market in the past several weeks, those working directly with clients would be wise to recognize the difference in their clients as they prepare for a long slog through a bear market.

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