Nothing like a little competition to prod some good work.

I am a bit of a research junkie, so last month in Baltimore where I attended this year’s FPA BE, the national conference of the Financial Planning Association, I was excited to see more interaction with the academic community and be exposed to some of the latest research useful to financial planners. 

The Journal of Financial Planning conducted a competition for financial planning research. Nine papers were selected by a blind peer review process. Three separate sessions were held in which researchers presented findings from their latest work. The research presentations were judged onsite by a panel. Two winners received cash and an award.

All nine were of interest, but I was not a judge, so I listened solely from the perspective of a financial planner looking for information I can use in my practice. A handful of the studies stood out to me.

One was named winner in the Best Applied Research category. Funded by the Ontario Securities Commission of Canada, “A Review of Risk Profiling Practices” was presented by Shawn Brayman of PlanPlus Inc., a Canadian financial planning software company.

PlanPlus attempted to examine a slew of risk tolerance questionnaires but due to a variety of factors, including a lack of cooperation among institutions and an inability to examine all questions or the scoring model, examined just 36 questionnaires.  

The headline result was that the quality of risk tolerance questionnaires covered a very wide range. This was not terribly surprising to me. What was a bit surprising was just how bad the bad ones were.

For instance, of the 36, less than twenty asked about basic items like age, income, net worth, investment knowledge, experience or goals. The authors described pervasive issues with the questions that were asked such as too few questions, confusing and poorly worded questions, and arbitrary or bad scoring models. They characterized three of the questionnaires as ”dangerous.”

Like many practitioners, I do not dispute the need to assess a client’s risk profile, but I have harbored some anxiety about putting too much emphasis on the results of questionnaires when constructing portfolios. There are too many other relevant variables. Our angst seems justified.

Another risk related study got the audience thinking. In “Who Exhibits Time Varying Risk Aversion?”, presented by Michael Finke, dean and chief academic officer at The American College, the authors looked at a pool of 29,000 retirement plan participants who used the exact same risk questionnaire from January 2006 through October 2012 to assess the relationship between the scores and the level of the S&P 500.

The authors wanted to see if any such link changed over time based upon demographic factors. Participants were segmented into quintiles by factors such as age, plan balance, income, savings rate and the present of their holdings in equities.

The headline here was that investors in the final decade before retirement showed the most variance in their scores. Their aversion to risk rose more substantially during market declines than other age groups. As you might expect, the result on performance was negative. The changes in aversion caused more “buying high and selling low.”

The authors conclude that the evidence is strong that risk aversion is time varying especially for older workers and that this makes risk coaching all the more important. 

On one hand, anecdotally in my practice, the years leading up to a retirement date tend to be among the most anxious for many clients. The clock is ticking and they worry an obstacle like a market correction will appear just as they put the pedal to the metal on their savings. That thinking, however, strikes me as a commentary on risk perception rather than risk tolerance. I’ll be interested to see if other data sets produce similar results.

If risk tolerance for any cohort is not very stable, using even valid risk tolerance results as a significant input for portfolio construction is less advisable particularly if changes in a score are used to make bad portfolio changes.

Imagine if regulators mandated that advisors only use portfolio structures that were mapped from a risk tolerance scoring system with higher scores resulting in more aggressive portfolio structures and lower scores directing to more conservative mixes. (Some jurisdictions around the globe are going in this direction.) If risk tolerance is not fairly consistent and the score declines with a bear market, the new map will point to reducing equity expose. Historically, reducing equity exposure is usually the worst course of action. 

Another aspect to risk tolerance that frequently arises in my practice is a significant difference between husband and wife. This difference is one of many reasons I believe there has to be some level of professional judgment and guidance involved when using risk tolerance tools. (The authors of the previously mentioned PlanPlus study noted with much chagrin that only one risk assessment process that included the ability for the advisor to override the results of the questionnaire and document the reason for the override). 

The differences between spouses may be why the winning entry in the other category, Best Theoretical Research, got my attention. “Savers and Spenders: Predicting Financial Conflict in Couple Relationships” presented by Sonya Britt from Kansas State asked, “What is the influence of spouse’s perception of spending personality on couple’s financial conflict?”

As is often the case in life both reality (whether one is more of a spender versus a saver) and perception (what one thinks about their spouse and what one thinks their spouse thinks about them) are factors. 

Using 2007-2015 Flourishing Family Data, Wave 2 (2008), the top predictor of stressed married men is a “spendy” wife. By contrast, the top predictor of conflict for wives was having a husband who thinks the wife is spendy, whether she is or not.

Other factors for the men were having too low an income, having three or more kids and having a wife who thinks he is spendy. Other factors for wives were having a lack of financial communication with husband and having a spendy husband.

With financial conflict, one of the leading predictors of relationship satisfaction and divorce, some couples may benefit from explorations of what “spendy” means to each person in the relationship and a discussion about the perception of each other’s saving and spending habits. Financial planners could benefit from learning better to facilitate those conversations.

The last study I will highlight was presented by Jacob Williams, a Texas Tech Ph.D. candidate. He titled his study after his curiosity, “Does the Level of Annuitization Affect a Retiree’s Financial Satisfaction?”

Prior research indicates a positive relationship between annuitization and satisfaction. This study hypothesized that the level of annuitization positively affected retiree’s financial satisfaction. However, the authors of this study controlled for variables not addressed in prior literature such as the “voluntariness” of the retirement decision.

The results indicated financial planners are not likely to increase satisfaction by increasing the level of annuitization. Rather, planners are more likely to increase satisfaction by following the established process of making a more complete assessment of client’s financial picture and recommending what is best given that specific client’s needs. 

The other studies presented were “The Determinants of Nest Egg Sustainability,” Presenting Author: Jack DeJong, Nova Southeastern University; “The Value of Communication in the Client/Adviser Relationship,” Presenting Authors: Christopher Browning, Texas Tech; and Jimmy Cheng, Winthrop University; “The Associations of Cognitive Abilities and Wealth: A Comparison of Elderly Married and Non-Married Households,” Presenting Author: Fred Fernatt; “Understanding Investor Risk Tolerance,” Presenting Author: Robert Moreschi, Virginia Military Institute; and “Financial Satisfaction: What People Know, Feel and Do from a Financial Perspective,” Presenting Author: Cliff Robb, University of Wisconsin.

The profession’s body of knowledge continues to grow. In the meantime, look for some of these to be published in the Journal of Financial Planning (free to FPA members) in the coming months. Some presentation slides can be found through the FPA Annual Conference website. Click on the “academic research sessions” in the conference schedule then click on “Session PPT”.

Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla. You can reach him at www.moisandfitzgerald.com.