The Development of a Risk Assessment Instrument: A Follow-Up Study

Abstract The purpose of this paper is to offer empirical evidence regarding the validity of a 13-item financial risk tolerance assessment instrument originally published by Grable and Lytton (1999) in this Journal. Bivariate and multivariate analyses were used to evaluate data from a sample of individuals who reported both having investment assets and making their own investment decisions. The analysis indicated that responses to the 13-item instrument were correlated with portfolio asset ownership as explained by Modern Portfolio Theory. These findings offer support for the concurrent validity (i.e., one form of criterion-related validity) and the construct validity of the assessment instrument. The paper concludes with a recommendation for further study, such as using the instrument in a longitudinal study to ascertain predictive validity. (C) 2003 Academy of Financial Services. All rights reserved. Keywords: Risk tolerance; Risk assessment; Validity; Portfolio choice 1. Introduction Financial planners and advisers have a fiduciary responsibility to assess the level of financial risk that can be tolerated by an individual investor (Morse, 1998). Until recently, the assessment of financial risk tolerance attitudes was conducted primarily through the use of one-dimensional measures (e.g., asking "do you gamble? "), qualitative assessments (e.g., asking "how risk tolerant are you? "), or proxies and heuristics (e.g., age is inversely related to risk tolerance). Researchers have long questioned the accuracy of these kinds of assessment techniques; moreover, the general consensus now suggests that attention turn towards the development of a psychographic-based standard assessment instrument (e.g., Hanna & Gutter, 1998; Roszkowski, 1996). Grable and Lytton (1999) presented a scale development framework and an instrument consisting of 13 items in response to the need for a valid and reliable (i.e., psychometrically designed) risk assessment instrument (Appendix 1). The research was noteworthy because the final version of the assessment instrument offered users a scale that was multidimensional, relatively easy to administer, and reliable. Grable and Lytton also offered support for the construct validity of the instrument (i.e., how meaningful an item or index is in multiple situations); however, they were unable to test for criterion-related validity (i.e., how accurate an item or index is in explaining actual behavior) because of sample limitations. Expanded use of the 13-item instrument has potentially been hampered by a lack of evidence related to the instrument's criterion-related validity. The purpose of this paper is to expand upon Grable and Lytton's (1999) original research by examining the criterion-related validity of the 13-item financial risk tolerance assessment instrument. Carmines and Zeller (1979) defined this aspect of validity as how accurately an instrument can estimate some type of behavior. This study was undertaken to test the accuracy of the 13-item risk instrument when explaining actual investment behavior. Obviously, from a practitioner point of view, this level of validity is very important. 2. Theoretical background Understanding and testing the validity of a risk tolerance scale builds on two disciplines of study. On the one hand, psychometric scale development and measurement of validity for a construct such as risk tolerance must be considered. On the other hand, the theoretical and practical implications of risk tolerance in influencing the choice of asset allocation models, investment products, and portfolio accumulation strategies must also be considered. A review of both topics follows. 2.1. Measuring validity of a risk tolerance scale Central to the development of any data-gathering instrument is a discussion of the quality of the scale as reflected by the characteristics of reliability and validity. Huck and Cormier (1996) summarize the essence of these measurement-related concepts, respectively, as consistency and accuracy, and go on to state, "accuracy requires consistency" (p. …