The science of psychometrics may have its roots in the ideas of Charles Darwin’s theory of evolution, but the considerably more modern practice of psychometric risk profiling is itself continuing to evolve.
Back in the 19th Century, the founding fathers of the then new discipline of psychometrics spent much of their time attempting to measure intelligence, developing Darwin’s theory that those individuals who can adapt will be more likely to survive. More than a century later that same strand of psychometrics has developed into the theory behind sophisticated tools that help advisers ensure clients invest in portfolios of assets that match their risk appetite as closely as possible.
Attitude to risk (ATR) profiling tools has only really been around for the last couple of decades. But even within the relatively short time that they have been in existence we have seen the way they are designed and used evolve considerably. This evolution has been fuelled by the growing amount of data upon which to base the theory behind these tools, regulatory and market changes and the financial services industry’s attitude to and acceptance of them.
When psychometric risk-profiling questionnaires were first developed they relied heavily on graphs, numbers and percentages. This number-heavy approach may have seemed logical to people working in the financial services industry at the time, but these early tools were deemed to be failing to communicate to people in language that they understood. The feedback from the regulator was clear: lots of people simply do not understand percentages and many find it hard to extract anything meaningful from looking at a graph.
This customer-centric emphasis led to a substantial overhaul of the format of risk-profiling tools, toning down the maths textbook-style examples and making them more user-friendly.
Changes to questionnaires have also come about as a result of the growing body of knowledge around how humans engage with and experience risk, both as a result of research based on user feedback and on the ongoing development of the psychology behind the questionnaires. Our very own expert psychologist is regularly weaving the latest academic research into the fabric of our tools.
One example of this is shown in the way an ambiguous middle answer in a scale can be seen differently by different people. Whilst “neither agree nor disagree” is designed to be used in context as the middle of a scale, it could also be potentially interpreted as having no opinion at all. Subtle changes in the wording used can have unintended consequences for the unwary and testing the questions is important to avoid bias.
A further big step-change in the use of psychometric risk profiling tools took place in 2011. The FSA issued new guidance for the use of risk-profiling tools after a review of client files found a large number of individuals were not being given portfolio recommendations that actually matched their risk profile.
A key lesson from the 2011 guidance was that, while risk profiling tools may have their roots in, and draw much of their credibility from, the science of psychometrics, using them effectively is as much an art as a scientific endeavour. Four years ago the regulator’s main point was that it was simply not enough to ask the questions to see what number comes out of the machine, rather that the questionnaire is the start of a conversation. Risk-profiling questionnaires are a part of the process, but the adviser, and their interpretation of the client’s responses and the ensuing debate that then follows remain very much an important part of the process.
Context has become increasingly important too. D2C tools have to be designed to be understood by the lowest common denominator, however clunky that may make them feel to some users. Adviser tools on the other hand can be more sophisticated because there is a professional involved in the conversation giving a further layer of interpretation to the responses.
The pension freedoms are also pushing forward further evolution of attitude to risk questionnaires, which are now having to adapt to increase their focus on income variability now that retirees are less likely to be relying on the guaranteed income delivered by annuities.
Risk-profiling tools will continue to evolve for as long as the market and regulatory environment in which they operate also change. What will remain constant is the need for advisers to remember that the science behind these tools can only ever tell half the story – it is the artistry of the adviser in responding to the client’s answers to the questionnaires and helping them find their overall risk profile that completes the picture.
Andrew Storey is technical sales director at eValue
