Evaluating an investor’s ability, willingness and need to take risk, and then designing his or her portfolio accordingly, are the most crucial functions of investment/financial planning and the “fintech” software that supports the profession. Thus, the ability to estimate an investor’s financial risk tolerance (FRT) is key to the success of a financial plan. Financial advisors know that psychological factors, such as financial anxiety, financial satisfaction (the knowledge that one has “enough”), obsession with money, personality type, self-esteem and sensation-seeking behavior, are all important contributors in determining an investor’s FRT – the willingness to accept financial risk.
Heena Thanki, Anushree Karani and Anil Kumar Goyal contribute to the behavioral finance literature with their study, “Psychological Antecedents of Financial Risk Tolerance,” published in the Fall 2020 issue of The Journal of Wealth Management. Their data sample included 386 individuals who participated in mail and online surveys. The study had seven variables: (1) financial anxiety, (2) FRT, (3) financial satisfaction, (4) obsession with money, (5) personality type, (6) self-esteem and (7) sensation-seeking behavior. The authors noted that the scales used to measure these variables have shown good reliability and validity in past studies. Following is a summary of their findings:
- The factors explain about 50% of the variation in FRT.
- Personality type A, self-esteem and sensation-seeking behavior are positively correlated with FRT.
- Financial satisfaction negatively influences FRT – people with higher financial satisfaction are risk averse and invest in less risky investment avenues.
- Obsession with money negatively influences financial satisfaction.
- Financial satisfaction is negatively correlated with financial anxiety.
- Financial anxiety positively influences risk tolerance.
