Risk Tolerance, Return Expectations and Other Factors Impacting Investment Decisions

Abstract

Do risk tolerance questionnaires predict risk-taking? Traditionally, investor preferences have been identified using risk tolerance questionnaires. However, there has been little focus as to whether the questionnaires are actually useful in predicting risk-taking decisions of investors and advisers. The purpose of this research was to review the existing literature and, using an online analytical survey, conduct a statistical analysis to determine the relationship between risk tolerance and risk-taking. The resulting quantitative analysis was complemented with qualitative interviews. The main findings are that return expectations and demographic variables are important predictors of risk-taking decisions, whereas risk tolerance questionnaires are not. A framework of two models was developed to better understand investment decisions. It forms the basis for a general discussion of the implications of these findings for practitioners and other stakeholders.

TOPICS: Wealth management, risk management, portfolio theory, portfolio construction

Key Findings

• ▪ Risk tolerance questionnaires do not predict risk-taking decisions by investors or advisers.

• ▪ Return expectations do predict risk-taking decisions by investors and advisers.

• ▪ Investor demographic factors (gender, marital status, net worth) and adviser demographic factors (education, licensing) also predict risk-taking.