As the U.S. economy slowly recovers, many investors remain wary about investing in the stock market. Investors’ “risk tolerance,” or their willingness to take risks, is an important factor for investors deciding whether, and how much, to invest in the stock market.
Now, Michael Guillemette, an assistant professor of personal financial planning in the University of Missouri College of Human Environmental Sciences, along with David Nanigian, an associate professor at the American College, analyzed the causes of risk tolerance and found that loss aversion, or the fear of losing money, is the primary factor that explains investors’ risk tolerance.
“Traditionally, it was believed that spending habits were the main driver of risk tolerance, meaning that the more variation an investor was willing to accept in their spending, the higher their risk tolerance for investments,” Guillemette said.
“Our study found that no such relation exists between risk tolerance and spending habits. Rather, loss aversion is a much more accurate indicator of risk tolerance. The more averse, or fearful, to losing money an investor is, the lower their tolerance seems to be for taking risks in the stock market. Consumer sentiment also appears to help explain investors’ risk tolerance, though not nearly as much as loss aversion.”
For his study, Guillemette, who is also a certified financial planner, analyzed data from a risk tolerance survey taken from 2003-2010. Guillemette focused on three potential drivers of risk tolerance: loss aversion, changes in investor spending habits and changes in consumer sentiment levels.
Guillemette says it is important for risk assessment instruments to measure loss aversion, especially during times when the stock market is performing poorly. He says knowing how much investors are willing to risk at the worst of times is valuable for financial planners tasked with creating long-term investment plans.
“Financial planners probably acquire more accurate information on client risk preferences when risk tolerance is assessed in a hot state when stock prices are falling, compared to a cold state, when stock prices are rising,” Guillemette said.
“Now that we know loss aversion is a key factor that drives risk tolerance, it is important for investors to take steps to reduce their loss averse tendencies. This includes viewing investment returns infrequently, as investors allocate a greater percentage of their portfolio to stocks if they view their returns on an annual, as opposed to monthly, basis.”
Guillemette says that encouraging investors to view their portfolios in a holistic manner also will help reduce loss aversion. Finally, he says research has shown that financial planners with the Certified Financial Planner™ designation can help increase investor certainty during periods of market turmoil.”
This study is forthcoming in the Financial Services Review.
Editor’s Note: Guillemette pronounces his name “Gill-uh-met”.
Nathan Hurst | Eurek Alert!
Microtechnology industry is hiring – positive developments of past years continue
09.04.2018 | IVAM Fachverband für Mikrotechnik
RWI/ISL-Container Throughput Index with minor decline on a high overall level
20.03.2018 | RWI – Leibniz-Institut für Wirtschaftsforschung
What if a sensor sensing a thing could be part of the thing itself? Rice University engineers believe they have a two-dimensional solution to do just that.
Rice engineers led by materials scientists Pulickel Ajayan and Jun Lou have developed a method to make atom-flat sensors that seamlessly integrate with devices...
Scientists at the University of Stuttgart and the Karlsruhe Institute of Technology (KIT) succeed in important further development on the way to quantum Computers.
Quantum computers one day should be able to solve certain computing problems much faster than a classical computer. One of the most promising approaches is...
New Project SNAPSTER: Novel luminescent materials by encapsulating phosphorescent metal clusters with organic liquid crystals
Nowadays energy conversion in lighting and optoelectronic devices requires the use of rare earth oxides.
Scientists have discovered the first synthetic material that becomes thicker - at the molecular level - as it is stretched.
Researchers led by Dr Devesh Mistry from the University of Leeds discovered a new non-porous material that has unique and inherent "auxetic" stretching...
Scientists from the Theory Department of the Max Planck Institute for the Structure and Dynamics of Matter (MPSD) at the Center for Free-Electron Laser Science (CFEL) in Hamburg have shown through theoretical calculations and computer simulations that the force between electrons and lattice distortions in an atomically thin two-dimensional superconductor can be controlled with virtual photons. This could aid the development of new superconductors for energy-saving devices and many other technical applications.
The vacuum is not empty. It may sound like magic to laypeople but it has occupied physicists since the birth of quantum mechanics.
06.12.2018 | Event News
03.12.2018 | Event News
28.11.2018 | Event News
07.12.2018 | Life Sciences
07.12.2018 | Materials Sciences
07.12.2018 | Physics and Astronomy