Fear of losing money affects investor risk tolerance

Jul 31 2014, 18:29 IST
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SummaryFear of losing money, and not spending habits, affects the willingness of investors...

Fear of losing money, and not spending habits, affects the willingness of investors to take risks in the stock market, scientists say.

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.

"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," said Michael Guillemette, an assistant professor of personal financial planning in the University of Missouri College of Human Environmental Sciences.

"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," Guillemette said.

For his study, Guillemette analysed 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 said it is important for risk assessment instruments to measure loss aversion, especially during times when the stock market is performing poorly.

He said 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.

The study will be published in the journal Financial Services Review.

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