Risk Profiling through a Behavioral Finance Lens

by Michael M. Pompian

This piece examines risk profiling through a behavioral finance lens. Behavioral finance attempts to understand and explain actual investor behavior, in contrast to theorizing about investor behavior. It differs from traditional (or standard) finance, which is based on assumptions of how investors and markets should behave. Much has been written about the tension that exists between the willingness to take risk and the ability to take risk. Risk appetite is the willingness to take risk and risk capacity is the ability to take risk. In the behavioral context, risk appetite and risk capacity are defined in terms of known risks and unknown risks. Irrational client behavior often occurs when a client experiences unknown risks. To aid in the advisory process, advisors can use Behavioral Investor Types to help make rapid yet insightful assessments of what type of investor they are dealing with before recommending an investment plan. With a better understanding of behavioral finance vis-à-vis risk taking, practitioners can enhance their understanding of client preferences and better inform their recommendations of investment strategies and products.

35 pages, Kindle Edition

Published February 28, 2016

About the author

Michael Pompian, CFA, CAIA, CFP, is the founder and chief investment officer of Sunpointe Investments, an investment advisory firm to entrepreneurs, corporate executives and multi-generational families, based in St. Louis, Missouri. He is the author of five books on behavioral finance, including his latest Behavioral Finance and Your Portfolio (Wiley, 2021).

As an experienced advisor, author, and pioneering researcher on the topics of behavioral finance and emotional investing, Michael has lectured on the practical application of behavioral finance world-wide. Recognized as a global authority, he has authored the CFA Exam Level III course curriculum in Behavioral Finance, has been published in journals such as The Journal of Wealth Management and Journal of Financial Planning, and wrote a monthly column on investing for Morningstar for 12 years. His work currently features in the curricula at Harvard, Duke and Dartmouth.

His books have helped thousands of financial advisors across the globe build better relationships with their clients. His newest work is designed to help individual investors recognize and better manage their investing biases, either independently or with their financial advisors.

Michael Pompian earned his MBA in Finance from Tulane University and a B.S. in Management from the University of New Hampshire. Outside work, Michael loves everything sports related: from watching and coaching youth sports to playing competitive tennis. Along with a family of three teenagers, he has two actively managed poodles and 6 passively managed guitars.