Understanding the Behavioral Risk Index

A number of behavioral factors influence the Behavioral Risk Index:

• Investor Type: Trend followers have higher behavioral risk than passive investors and contrarians..
• Risk Inconsistency: If the results of the risk tolerance assessment match, it confirms the accuracy of the result. If the investor chooses a portfolio above their psychological risk appetite, it is a red flag.
• Financial IQ: Assesses the investor’s financial knowledge and understanding.
• Behavioral Biases, including loss aversion, overconfidence and herding. The stronger the behavioral biases, the higher the behavioral risk.
• Describe Yourself also includes a few contributing factors such as logical/emotional, spending habit, and thinker/follower.

• Low behavioral risk (1-4): You usually stay calm during marketing turmoil, taking a long-term approach, which is the right perspective.
• Medium behavioral risk (5-6): You might experience some stress during market fluctuations, but make an effort to maintain composure and avoid making emotionally-driven investment decisions.
• Medium high behavioral risk (7-8): You might experience stress and anxiety during market turmoil, which might prompt you to make emotionally-driven investment decisions. Investment decisions driven by emotions tend to have detrimental effects on your financial goals.
• High behavioral risk (9-10): You might experience significant anxiety during market turmoil, which might prompt you to make emotionally-driven investment decisions. Investment decisions driven by emotions tend to have detrimental effects on your financial goals.

Portfolio allocation primarily depends on an investor’s risk tolerance and time horizon. The Behavioral Risk Index does not directly impact asset allocation but helps advisors tailor their support to keep clients steady during market fluctuations.

One could argue that for investors with similar risk tolerance and time horizon, those with lower behavioral risk can go a bit more aggressive, and those with higher behavioral risk should take a step back. This is perfectly justifiable. We don’t take this approach because behavioral profiling is an ongoing process. Your behavioral risk index can change as you take more tests, and it doesn’t make sense to change your portfolio because of this; instead, your advisor will provide more hand holding as needed.

The Behavioral Risk Index is a valuable tool for financial advisors, helping you understand and manage clients’ emotional responses to market changes. During market turmoil, you can use it to prioritize the outreach to provide hand holding to those who need it the most.