Sherman Hanna is a professor of consumer sciences at The Ohio State University. He is also the co-author of a new measure that he says is a better way to calculate how much risk people are willing to take in their investments. It has an interesting twist.According to Hanna, financial planners are in agreement that measuring risk tolerance in their clients is highly important; however, he contends that there has been, up to now, no generally accepted way to do it. "A lot of the measures that are used are based on intuition and are not backed by solid research." In fact, he points out that many such measures wind up asking highly complicated questions that he feels many people simply do not understand. Hanna's new measure and a study testing it are published in an issue of the journal, Financial Counseling and Planning.
He maintains that many surveys measuring risk tolerance have results that aren't plausible. He cites one example, of many: one survey found that nearly one-quarter of respondents aged 51 to 61 had very high risk tolerance and suggested that they would be willing to take greater risks with their portfolios. These, he says, are the same people are who close to retirement and presumably would be more interested in protecting what they have.
Consequently, Hanna's measure uses a series of questions which, unlike most other measures, are based on economic theory about risk aversion as it relates to optimal investment portfolios.
Hanna tested his new measure with a sample of Ohio State students and he found the results much more reasonable than the other surveys. For instance, most respondents, he says, had risk-tolerance levels that were consistent with an all-stock retirement portfolio until middle age, and then stock allocations decreasing to some 40 percent by retirement. He believes this is more in line with what financial planners recommend for young investors today.
He would like to repeat the survey with a larger, more diverse sample so that he can better validate it with people of all ages. "People need to understand their level of risk tolerance in order to make the proper investment decisions." If you would like to take the survey, go to http://hec.osu.edu/people/shanna/rts.
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