Over the course of a risk profiling exercise undertaken with prospective clients, advisors attempt to gain insights into the financial behaviour of a particular client. Apart from client responses to questionnaires and other risk profiling tools, the inherent personality of a client can also serve as a significant source from where advisors can gain and analyse information regarding the client’s financial behaviour. The Bailard, Biehl and Kaiser (BB&K) investor personality model is quite helpful in this regard. And in today's blog post I'm going to focus on the various aspects of the BB&K model. I'm going to list out the various types of investor personalities, the peculiar features of each group of investors and the challenges advisors are likely to face when working with each personality type. I will end by showing how the BB&K model can be used in conjunction with traditional risk profiling tools to provide risk profile analysis with greater accuracy and relevance.
The BB&K Test classifies investors into five distinct categories namely Adventurers, Celebrities, Guardians, Individualists and Straight Arrows. The classification is made based two major dimensions. These being the level of confidence with which an individual makes decisions (ranging from anxious to confident) and their approach to decision making (ranging from careful to impetuous, meaning impulsive). So this test acts as a reflection of the individual's behaviour in various aspects of their lives, including investing and money management. The various personality types as classified by the BB&K test are depicted in the graphic that follows.
The first investor personality type is that of the individualist. Such people are fiercely independent and prefer to make their own decisions as far as possible. They carefully analyse and weigh up the pros and cons of each potential option available to them before making a decision. This rational approach to decision making allows them to make decisions with a reasonable degree of confidence. But at the same time, they may tend to analyse things a little too much therefore occasionally leading to a gap between thought and action. This may mean that they may lose out on opportunities that are ideal for them, owing to the delay in initiating action.
Adventurers on the other hand are highly confident and more willing to take risks. They would have no problems staking a substantial portion of what they have into a single idea or opportunity, if they find that there could be something beneficial in it for them. But they are highly unlikely to listen to wise counsel exhibit a high degree of impulsiveness when making decisions. And this sees them lose badly at times, sometimes even to the extent where the losses they suffer may be irreversible. So the common issue shared by individualists and adventurers is with regard to the speed of decision making. And this is the major challenge for advisors when dealing with clients of these personality types. They must ensure that individualists press forward into action after a reasonable amount of deliberation, while encouraging adventurers to slow down and think things through a little bit more before acting on their thoughts.
Investors with the Celebrity personality type usually have the confidence to take on risks, but carry the inherent fear of missing out on a given opportunity. They therefore try to participate in every investment opportunity that comes their way, regardless of whether or not the opportunity is ideally suited to their needs. They therefore willingly listen to and get influenced by any investment advice that comes their way, be it from formal or informal sources. Therefore, the biggest risk faced by such investors is that of falling into the hands of unscrupulous advisors. This could see them make some extremely ill informed decisions which come back to haunt them. Investors of the Guardian personality type are in many ways the polar opposites of those with a celebrity personality. Guardians usually encompass senior, more mature and prudent investors. They are those who are more likely to have created significant wealth and therefore looking to protect it. They therefore prioritise capital preservation over maximising returns and actively seek out investment advisors as prudent as they are and well reasoned investment advice. The underlying issue that is common to these two categories of investors is that of fear. And helping these investors overcome their respective fears is the foremost challenge that advisors would face when working with these categories of investors. In case of celebrities, advisors must make them realise that missing out on a few opportunities is okay and probably even beneficial for their financial health. A few strategies that can be worked upon are listed in the graphic that follows.
In the case of guardians, fear manifests itself through the fact that they wish to avoid risks as far as possible. But excessive aversion to risk may give rise to inadequate returns, thereby leaving guardians at the risk of outliving their money. Advisors must therefore encourage guardians to keep a small portion of their wealth in riskier assets such as equities and other market linked assets at all times. This would ensure long term portfolio growth at a stable pace along with better tax efficiency.
This leaves the final kind of investor personality, the Straight Arrows. Investors in this category are usually the most well balanced and display a near perfect mix of confidence when acting on decisions and prudence when arriving at them. Such a balanced approach to investment decision making means that their investment behaviour has very few weaknesses of note, if any. Therefore their investment behaviour can be considered to be ideal, even for the other categories of investors prescribed by the BB&K model. This is why straight arrow investors find their place bang in the central region of the model. As far as advisors and their involvement with straight arrow investors is concerned, they actually have very little to do with straight arrows. Rather, an advisor's endeavour must be to coach other categories of investors to a point where their investment behaviour reflects that of a straight arrow investor.
Traditional risk profiling tools such as questionnaires and situational analysis involve eliciting a response from a prospective client after allowing them some time to think before responding. This may lead to situations where respondents are not completely honest with their responses. And given that the investment advice imparted by the advisor is heavily dependent on the client’s responses to the risk profiling tools presented to them, the advice imparted based on partially honest responses would ultimately go on to produce suboptimal results. On the other hand, a client's inherent personality and behaviour cannot be hidden or manipulated for too long. Therefore the categorisations as per the BB&K model would provide a much more realistic reflection of an investor’s risk profile, thereby improving the suitability of investment advice imparted to them. Of course, it would take an advisor some time to fully understand the personality of a client and categorise them as per the BB&K model. Given that such would be the case, client responses to traditional risk profiling tools can be used as a starting point to impart advice during the initial phase of the engagement. As the advisor gains a better understanding of the client’s personality, dependence on the BB&K model can be progressively increased. Such an approach would ensure that risk profiling is a lot more effective the most relevant and suitable advice is imparted to each client over the course of the advisory engagement.