An empirical investigation from a financial planning perspective of the factors that influence the financial risk tolerance of individuals
- Publication Type:
- Thesis
- Issue Date:
- 2008
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| Filename | Description | Size | |||
|---|---|---|---|---|---|
| 01Front.pdf | contents and abstract | 732.78 kB | |||
| 02Whole.pdf | thesis | 78.34 MB |
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NO FULL TEXT AVAILABLE. Access is restricted indefinitely. ----- When formulating an asset allocation, financial planners not only have a fiduciary
obligation to be completely aware of the desired risk tolerance of their clients, but they
are also required under the Financial Services Reform Act to assess the risk profile of
their clients. Since the development of financial risk tolerance assessment
methodologies, academic studies have attempted to determine the extent to which
biological, demographic, socio-economic and psychological factors influence the
financial risk tolerance attitudes of individuals. However, risk tolerance research often
produces inconsistent and controversial findings, with the majority of studies also
reporting low ·explanatory power and subsequent ineffectiveness in the factors that are
assessed as predictors of financial risk tolerance.
Through applied research, the aim of this thesis is to provide practitioners with a better
understanding of financial risk tolerance, its assessment, and the factors that are related
to financial risk tolerance. This thesis will enable financial planners to develop optimal
asset allocations that accurately consider the financial risk tolerance profile of their
clients. Due to the substantial inconsistencies in the findings of academic studies, I
conduct three surveys to investigate financial risk tolerance. The first survey (Financial
Planners Survey) is designed to determine the financial risk tolerance perception of
financial planners by examining each of the most widely tested factors identified in the·
existing financial risk tolerance literature. Based on their responses, as well as the
findings of various academic studies, the second (Smart Investor Survey) and third
(Risk Tolerance Survey) surveys regress these factors to financial risk tolerance scores.
In the survey of financial planners, I find extreme inconsistencies in respondents'
interpretations of a standard set of information concerning a hypothetical client. I
propose that the inconsistencies are attributed to the fact that providing financial advice
relies on subjective judgment, a process open to multiple interpretations based on the
financial planner's own knowledge, experience, intuitions and skill sets. I find evidence
of differences in the influence of variables on financial planners' clients, and conclude
that inconsistencies in asset allocations can be attributed to a combination of intuition
and knowledge gained from clients with similar demographic characteristics. The asset
allocation process is further complicated by the existence of various behavioural biases,
including overconfidence in the prediction of future return and risk estimates. Using the
same survey dataset, I conclude that financial planners are not immune to
overconfidence in their knowledge and ability to predict outcomes of financial markets.
From the two risk tolerance surveys, financial risk tolerance is found to be related to a
number of variables including gender, age, home ownership, income, wealth,
entrepreneurship and financial knowledge, while it has no significant relationship to
marital status, education and household size. Due to the low explanatory value of the
majority of academic studies, the survey of financial planners also identifies additional
and untested factors that could possibly influence financial risk tolerance. I incorporate
a number of these suggestions, as well as several alternative factors that were
investigated on an ad-hoc basis by previous academic studies, and conclude that a
number of variables associated with an individual's current and future financial and
investment circumstances, as well as several psychological and personality factors, are
related to financial risk tolerance. Incorporation of these unexplored variables into a
series of regression models results in substantially higher R2 and adjusted-R2 values
compared to those of previous academic studies. As a result, the predictors of financial
risk preferences identified in this thesis are more extensive than the previously assumed
basic demographic constants and include attitudinal variables such as experiences,
expectations and goals.
Finally, I conclude that financial risk tolerance is a fixed psychological trait due to its
positive relationship to anum ber of psychological variables. Minimal changes in annual
financial risk tolerance scores are observed in a longitudinal analysis. Tills fixed trait
conclusion is supported by the failure of a regression model developed from major
demographic and socio-economic variables to predict changes in financial risk tolerance
scores.
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