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Financial Planning > Behavioral Finance

Questionnaires Are the Root of All Evil in Financial Services, Professor Says

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Financial decision-making is a challenging, complex puzzle of balancing goals, limitations and trade-offs. Advisors seek to achieve this ideal state based largely on client surveys and questionnaires. Alas, “surveys and questionnaires are the source of all evil and bad in the financial services industry,” argues Shachar Kariv, an economics professor at the University of California, Berkeley, and a leading decision theorist, in an interview with ThinkAdvisor.

These written question-and-answer quests for insight are unscientific, and not only do they fail to reveal how clients make investment decisions, they’re costly as well — “a killer combination,” contends Kariv, recent chair of Berkeley’s economics department.

The way to scientifically discern investors’ attitudes about risk and other money issues, Kariv says, is to use a totally different method, one that models clients’ choices and simulates the investing experience. Bring on: gamification.

Indeed, Kariv touts an electronic gamified approach, using graphical shapes, that he developed based on mathematics, game theory and behavioral economics principles.

By making investors face risk and loss, TrueProfile strives to “capture the essence of investing,” says Kariv, chief scientist and co-founder of TrueProfile, a subsidiary of Capital Preferences.

In a series of games, investors are asked to make tradeoffs and choose among various portfolios. The games — which clients can “play” in the presence of their advisor or on their own — were tested globally for more than a decade with several thousand people before their 2017 rollout.

ThinkAdvisor recently interviewed Kariv, on the phone from Berkeley. He joined the university in 2003, the same year he received New York University’s Outstanding Dissertation Award in the Social Sciences. His paper showed that rational behavior can lead to herd behavior — a mentality that often generates stock market booms and busts.

Here are highlights of our interview:

THINKADVISOR: To learn more about clients, advisors typically ask them to fill out surveys and questionnaires.  How helpful are these? 

SHACHAR KARIV: Surveys and questionnaires are the source of all evil and bad in the financial services industry. Surveys are the Achilles heel of the industry. They don’t do the trick, and they’re very costly. It’s a killer combination. They put the entire industry on very shaky ground.

Why is that?

Asking someone, “How risk-averse are you?” is like asking, “How many white blood cells do you think you have?” Surveys and questionnaires are the tools we use for understanding the client, but they have no scientific basis whatsoever. Until we fix this, very little can be done.

But isn’t there anything useful in questioning clients this way?

Maybe I’m not the financial advisor’s average client; but every time I go to one and he gives me a survey to answer, it makes him look stupid. He asks stupid questions. If you’re asking silly questions, all you can give are silly answers. It’s “garbage in, garbage out.” I think the advisor just files the questionnaire. He doesn’t really look at it.

To know oneself as an investor, do you need the help of a financial advisor?

Absolutely. If someone thinks we can provide good financial well-being by eliminating financial advisors and make them go to robos [advisors], that’s not the way. Financial decision-making is becoming more complicated. Providing financial well-being is as important as providing physical well-being — medical care. I’m holding advisors to the same level that I’m holding physicians.

What goes into knowing yourself as an investor?

It’s knowing your goals, constraints and preferences. Financial decision-making is a very complicated puzzle consisting of balancing those three pieces.

Please elaborate.

Goals can be “I want to retire” or “I want to renovate my kitchen.” Constraints can be how much money you earn, current health and future health [issues] that you can’t anticipate. Preferences are [tradeoffs investors need to make]: risk vs. return; whether you want something today or are willing to wait till tomorrow; and whether you want to leave money to [for example] your kids. To figure out those three pieces of the triangle, we need a professional to help us. Are financial advisors equipped to do that? I don’t think so.

Please talk more about tradeoffs.

All financial decisions are governed by those three tradeoffs: risk vs. return, today vs. tomorrow, you vs. others — that is, my well-being vs. the well-being of others.

How important are tradeoffs in making financial decisions?

Very important and very complicated. For example, when someone buys an annuity, they’re removing risk because they get a guarantee and a stream of payout in the future. However, you need to pay for the annuity now. So that’s a tradeoff between today and tomorrow. There’s a risk vs. return tradeoff as well: When you buy an annuity, you eliminate longevity risk, but to know your longevity risk is impossible.

The positives about annuities are attractive, but an annuity may not be right for every client, right?

Annuities can be good products. But it’s exactly like saying a hip replacement operation is a good product. I’m sure it is — for some people. What if you go into the hospital and they give you a menu: hip replacement, bypass operation [etc.] and ask: “What do you want?”

“I don’t know,” you say.

“Well, we have a good bypass operation. Do you want one? Our survey shows you need bypass surgery.”

Joking aside, the advisor really needs to know the investor. To tell someone that if you buy this annuity, we’re going to give you guaranteed income of $8,000, you need to know the investor — and the investor needs to be convinced that the advisor knows them [well] enough.

Please elaborate on the today vs. tomorrow tradeoff.

The industry doesn’t register today vs. tomorrow, and no regulation forces advisors to have a time questionnaire, only a risk questionnaire. I would argue that risk profiling is done very, very poorly, and time profiling isn’t done at all.

So if surveys and questionnaires are ineffective, as you say, what’s the alternative?

We need to move from stated preferences [asked for in questionnaires and surveys] to revealed preferences. I would argue that we have the best method with TrueProfile. You can [also] look at Riskalyze, which many people are using. But that’s a paper airplane; our method is a fighter jet!

Why is TrueProfile so strong?

We’re trying to capture the essence of investing, which is making tradeoffs, risk vs. returns and today vs. tomorrow. It’s like a flight simulator for investing. We’re simulating choosing between different investment portfolios. As the clients play the games and make choices, they’re revealing their preferences. Actions speak louder than words [stated preferences].

What’s another advantage?

If, for example, you’re loss-averse, by playing the games, you’ll understand yourself and ask your advisor to help you: “Please don’t put me in a too-risky portfolio because now I know I’ll sell at exactly the wrong time.” So the games increase communication with the advisor.

What precisely is loss aversion?

People will be willing to take a risk when it’s about gains and unwilling to take a risk when it’s about losses. This is very deeply inherent in human behavior. We are more averse to losses.

Please provide an illustration?

Say you just earned $1,000 unexpectedly. Think about how happy it will make you. Now think about losing $1,000 unexpectedly; that will make you unhappy. Losing $1,000 will make you more unhappy than gaining $1,000 will make you happy. So when markets go down, that’s when the loss-averse client wants to sell.

What does that mean to the advisor-client relationship?

The advisor needs to do more hand-holding with this client, providing education and explanations. That’s exactly why we have an advisor.

Is it helpful for the FA to tell clients the level of their risk aversion?

If a financial advisor tells you that your risk aversion is six, it doesn’t mean anything — only that it’s a larger number than five and smaller than seven. If he tells you that because your risk aversion is six you need to have a conservative portfolio, it means nothing. So these common methods are useless.

What’s risk tolerance, then? Advisors always seek to know that about clients.

It’s the mirror of risk aversion. Advisors talk about risk tolerance; academia talks about risk aversion. It’s the same thing. The more risk-averse you are, the less risk-tolerant you are. If you’re infinitely risk-averse, you can’t tolerate any risk; and your risk tolerance is zero.

And then there’s ambiguity aversion. What’s that one about?

It’s the aversion we have for unknown probability. People are not only averse to something that’s uncertain; they’re also averse to the fact that the probabilities are unknown.

What’s an example?

Stocks aren’t risky assets; they’re ambiguous assets because you can’t assign probability to their going up or down. Stocks in emerging markets are less risky than [U.S.] stocks, but we have widespread ambiguity about emerging markets’ stocks because we have less information about them.

How would you sum up the critical issue of advisors needing to know what clients are about in order to determine their investing needs?

The work of the financial advisor is very much like the physician’s. With an advisor, the diagnosis is based on the person’s goals, constraints and preferences. The treatment is to give him a financial plan — a portfolio. But if you don’t know his goals, constraints and preferences, how can you give him a treatment?

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