4.1 Psychometrics

Psychometrics is the field of study connected to psychology and statistics with concerned to the measurement "psychological" aspects of a person such as knowledge, skills, abilities, or personality. Measurement of these unobservable phenomena is difficult and much of the research and accumulated art of this discipline is designed to reliably define and then quantify. Much of the early work in psychometrics was developed in order to measure intelligence.

More recently psychometric theory has been used in measurement of personality, attitudes and beliefs, academic achievement, and in health related fields, to measure quality of life. The key concepts of psychometrics (classical test theory) are reliability and validity. A reliable measure is measuring something consistently, while a valid measure is measuring what it is supposed to measure.

Financial Advisors face several key issues when considering how to best develop an understanding of the risk tolerance of their clients.

• What is risk tolerance?
• Why is it important that Financial Advisors understand the risk tolerance of clients?
• How should Financial Advisors go about obtaining an understanding of their client's risk tolerance?
• What should Financial Advisors look for in a risk tolerance test?

We hope the psychometric principles presented here will help the financial planning profession design better tests, and that all readers will be better able to assess the validity of third-party questionnaires or their own questionnaires they may want to use on their clients.