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Practice and client management Risk management


CAN A PERSONALITY TEST HELP CLIENTS MAKE BETTER INVESTING DECISIONS?

By  Brian Wallheimer October 14, 2021, 1:33 p.m. EDT 7 Min Read
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Jim Exley stared down at a new client’s risk score and couldn’t comprehend the
number he saw. Earlier in the day, the client had talked about how, in addition
to his role at a Fortune 500 company, he had covert side gigs — including
selling stereo equipment out of his car — that could have cost him his job.

This guy was willing to take significant risks, but the assessment told a
different story, triggering a much more conservative risk profile than his own
anecdotes about his life would indicate.

“When you give him the risk tolerance profile, he does it so you have got to put
it all in money markets,” said Exley, an advisor, researcher and wealth
management coach in Alpharetta, Georgia



Exley looked to another set of data to reconcile the disconnect — a personality
test. In particular, he used the Big Five O.C.E.A.N. test, which he and
colleagues Patrick Doyle, Michael Snell and W. Keith Campbell recently used to
understand how personality can predict financial behaviors and outcomes. Their
findings were published in the Journal of Financial Planning.



In Exley’s case, the client’s personality turned out to be seriously
extroverted, which suggests he’d be willing to take on more risk. But extroverts
also tend to have lower financial literacy, the authors found, which likely
caused him to answer the risk assessment questions conservatively.

“Personality science gives me important clues,” Exley said. “There’s more going
on in a person’s life than risk tolerance.”

Research findings
Exley, Doyle, Snell and Campbell surveyed more than 400 people to determine how
personality and finance interact. Subjects gave demographic data, including
wealth accumulation and annual income, and took tests that assessed their risk
tolerance and financial literacy. Those attributes were matched with the
O.C.E.A.N. test that assesses personality based on openness, conscientiousness,
extraversion, agreeableness and neuroticism.

The goal is to give advisors and planners another tool to assess how to interact
with their clients to help them reach their financial goals. Campbell said risk
tolerance is helpful, but only tells part of the story.

Practice and client management
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them down
October 4, 2021 11:41 AM

“We can ask questions and get a measure of risk, or get personality into play
and learn more,” he said. “Those measures that are only behavioral aren’t very
stable, whereas the personality traits are more stable and last over time.”

The authors found that certain personality traits were positively or negatively
associated with financial behaviors and outcomes. Most important for advisors
and planners are the connections to financial literacy and risk tolerance.

Financial literacy: Positively associated with openness (O), conscientiousness
(C) and agreeableness (A); and negatively associated with neuroticism (N) and
extraversion (E).

“When assisting individuals high in C and O, planners may see higher financial
aptitudes,” the authors wrote. “High Os and Cs may benefit from more detailed
explanations of advanced topics involving their investing and planning. This
advanced learning should allow high Os and Cs to grasp more complex strategies
that may assist in reaching their goals.”

On the other hand, advisors might have to come up with different ways to educate
those who display neuroticism or extraversion.

“While high Ns may readily admit this shortcoming, high Es may deny low
financial literacy, as high Es can be prone to overconfidence,” they said.
“Planners assisting high Es and Ns should consider creative ways to spend time
on basic financial literacy in review meetings rather than assigning
self-learning tasks these individuals may not value or complete.”

Risk tolerance: Positively associated with extraversion; and negatively
associated with openness, conscientiousness and agreeableness. The issue here is
convincing conscientious and agreeable people to take greater risk when it’s
necessary.

“Planners may consider more detailed explanations of the costs and benefits of
risk, appealing to high Cs’ and As’ higher financial literacy,” the authors
wrote.

Those displaying extraversion, however, might be willing to take on too much
risk.

“When assisting individuals with high E, planners should be mindful that big,
extroverted personalities tend to add risk even when it may be detrimental to
their long-term goals. Spending extra time evaluating and understanding high Es’
risk tolerance over and above industry protocol should be beneficial with these
clients,” they wrote. “A ‘sandbox strategy’ or ‘trading account’ consisting of a
small set of risky assets that are fun to discuss at cocktail parties may
scratch the risk itch while not endangering the entire financial plan.”

The importance of personality
About a year ago, Brent Weiss, co-founder and chief evangelist of Facet Wealth,
an advisory firm offering flat-fee planning to mass-affluent clients, started
thinking hard about the role psychology plays in financial advising and why so
many people don’t take the financial advice of professionals.

“The financial advice given to people, they don’t take action on. Less than 20
percent of financial advice is implemented. What is the reason for this?” Weiss
said. “No. 1, it doesn’t take into account the psychology of how you think about
money. If I don’t know how you interact with money, my advice might not be right
for you.”

Investment funds
MIT study finds older men are more likely to panic-sell stocks
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Weiss not only considers personality, but he tries to understand the seminal
moments or issues that influence how clients think about money. Someone may be
wealthy, but if they grew up poor, they might be unwilling to take on too much
debt or take large risks.

“I might say, ‘I can get you 8%,’ but you had a horrible financial history,”
Weiss said. “The first time the market drops, people sell and it destroys their
investment plans.

“I might think max return is best, but I need to consider what they’ll stick
with,” he added.

Jacquette Timmons, a fInancial behaviorist and president and CEO of Sterling
Investment Management in New York City, got interested in financial behavior
when the economy soured in the 1980s. She was shocked at the difference between
those who were content to ride out the downturn and those who panicked. She
figured that those differences needed to be accounted for to nudge people toward
good investment decisions.

“Back then, we would have asked a few questions, plunked it into some software
and it would have said ‘this is your risk tolerance,’” Timmons said. “But if
success with money were a mathematical equation, this would be a much different
conversation.”

She recommends advisors help clients determine their attitudes toward the
non-money things in their lives and use them to make better investment
decisions.

“How do we take your strengths and apply that to money?” she said. “This could
be good for an advisor, saying that this will not only help me understand you
but help me make better financial decisions on your behalf. That will go a long
way.”

Aaron Klein, CEO of Riskalyze, a company that provides portfolio risk assessment
software to financial advisors, leans more heavily toward an analytic approach
to assessing risk tolerance. He believes that emotions can cloud the right
decisions, and his company tries to strip that out to give advisors objective
risk scores for clients.

“We were put on Earth to help advisors set aside behavioral personality issues
and figure out how to harness behaviors to get to the right outcomes by really
trying to remove the emotion from the decisions and bring logic and data to
decisions,” Klein said. “The quantitative approach takes a client through an
explanation about where they prefer risk and where they prefer certainty using
dollar amounts that are relative to them.”

While Klein said personality and qualitative data might help an advisor connect
with a client, he doesn’t believe it should drive investment decisions.

“Extroverts tend to have more positive sentiment about the thrill of investing.
That does not drive the actual decisionmaking,” he said. “The personality
doesn’t change. It’s fairly hard-wired. It will drive qualitative risk questions
to tilt a certain way based on personality. But it’s not capturing actual risk
tolerance.”

Still, he suggests that understanding some of the whys of a risk assessment is
important. Once a risk score is computed, advisors are expected to learn more
about the factors that led to a particular number.

“It is through that discussion that we actually learn a lot about our clients
and what motivates them. It’s the motivation that drives the action,” Klein
said.

Putting it into practice
Certainly, getting to know clients over yearslong relationships can tell
advisors a lot about personalities. But for those who can’t interact
face-to-face with clients as often, especially during the COVID-19 pandemic, or
those who are taking on new clients, there are personality tests that could
help.

The authors used the NEO-IPIP 60, a survey that assesses people based on the
O.C.E.A.N. criteria. Exley said administering the tests and scoring them is easy
for advisors to pick up and can make a significant difference in their client
relationships. A version of the test and more information can be found at
oceantool.me.

“We’ve taught the language to the advisors,” Exley said. “Planners, regardless
of experience, can understand O.C.E.A.N. really well.”

Brian Wallheimer
Managing editor, Financial Planning
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