Impact of Self-Esteem on Financial Risk Tolerance

The way self-esteem affects the financial risk tolerance, is defined as a subjective evaluation based on feedback received from others concerning appearance, behavior, and other personal traits.

Dickson and Krueger concluded that individuals who perceive themselves as good decision makers were more likely to take risks as compared with others, especially those who were filled with self-doubt. Results of these and similar studies point to a common link between psychosocial factors such as self-esteem and risk taking and risk tolerance [Haliassos, M., & Bertaut C. C., (1995)].

Thomsett (2002) asserts that high self-esteem is an attribute of ‘financially’ successful people, a view that is shared by Michael et al (1989), Baird and Thomas (1985) and Chusmir (1983). In establishing the positive relationship between self-esteem and risk tolerance, Hofmann (2007) described that investors with higher levels of self-esteem were likely to be able to handle the anxiety of undergoing a financial loss better, a factor that would otherwise limit the risk taking ability of less confident investors. There is a possibility that self-esteem affects wealth creation and portfolio allocation if more confident individuals are more confident about investing in instruments they are not very familiar with. However, several other researchers also agree that while high self-esteem in making investment decisions may yield historical financial results, excessive self-esteem may lead to excess trading or inability to realize a substantial loss (Baron, 2008; Baumaeister et al, 1993).

Investors who make bad investments to justify the losses incurred in an underperforming asset have been studied by researchers in the context of self-esteem and risk tolerance- the phenomenon of incurring losses on losses has been established as an individual’s attempt to maintain self-esteem or save face, since regret leads to lowered self-esteem level (Arkes & Blumer, 1985; Brockner and Rubin, 1985; Ramona et al, 1994). Maintaining a pessimistic attitude to certain investments is found to be a defensive attempt to curb the decrease in self-esteem of respondents on event of a failure (Mansour et al, 2006). Similarly, Tykocinski et al (2004) found that investors are likely to admit a failure in investment and unwilling to cut losses.

In summary, we can quote the following authors’ views on the impact of self-esteem on financial risk-tolerance:

1. Higher self-esteem and self-efficacy leads to greater risk-taking (Columbus, 2007, p.17). Columbus states that risk taking is primarily dependent on an individual’s self-esteem, and the higher the self-esteem, the higher the level of risk tolerance.
2. Differences in risk preferences are attributed to self-esteem (Knight and Nadel, 1986).
3. High self-esteem is an attribute of financially successful people, as they are more open to risk-taking (Thomsett, 2002, p. 90). Thomsett here states that financial success is to be attributed to self-esteem of an individual.
4. People with high self-esteem are assumed to more risk tolerant (Xiao, 2008, p.12). Xiao’s assertion is similar to Thomsett’s.
5. An entrepreneur is expected to have a perceived sense of self-esteem and competency in conjunction with his/her business decisions (Robinson et al, 1991, pp. 13-31).
6. Self-esteem and previous experiences affect the willingness to risk, tolerance for temporary failure and expectations of success (Miller and Stockel, 2010).
7. Low self-esteem people are especially likely to behave in prosocial ways like taking financial risks (Vohs, Baumeister and Loewenstein, 2007, p. 172). These risks may hurt them but also might help their social group.
8. Risk tolerance is a journey that is often influenced by person’s self-esteem (Hasse, 2010; p.32)
9. High self-esteem leads to increased risk-tolerance because if we feel good about ourselves, we are more likely to trust our judgments of potential hazards in a situation, and be willing to tolerate higher levels of ambiguity in new situation (Leatz and Stolar, 2010; p.333)

References

• Haliassos, M., & Bertaut, C. C. The Economic Journal, 1995.
• Thomsett, M. (2002). J.K. Lasser’s Buy, Sell, Or Hold: Manage Your Portfolio for Maximum Gain. John Wiley & Sons, USA
• Michael, R.T.; Hartmann, H. I.; O’Farrell, B. (1989). Pay equity: empirical inquiries National Academic Press: National Research Council (U.S.). Committee on Women’s Employment and Related Social Issues
• Baird, I.S. and H. Thomas (1985). Toward a contingency model of strategic risk taking. Academy of Management Review 10: 230-243.
• Chusmir, L. H. (1983). Characteristics and predictive dimensions of women who make nontraditional vocational choices. The personnel and Guidance Journal
• Hofmann, K. P. (2007). Psychology of decision making in economics, business and finance. NY: Nova Scotia Publishers
• Baron, J. (2008). Thinking and deciding UK: Cambridge University Press
• Baumeister, R. F.; Heatherton, T.F. & Tice D.M. (1993). When ego threats lead to self-regulation failure: Negative consequences of high-self esteem, Journal of Personality and Social Psychology, 64, 141-156
• Arkes, H. R., & Blumer, C. (1985). The psychology of sunk cost. Organizational behavior and human performance, 35(1), 124-140.
• Mansour, S. B., Jouini, E., & Napp, C. (2006). Is there a “Pessimistic” bias in individual beliefs? Evidence from a simple survey. Theory and Decision, 61(4), 345-362.
• Columbus, A. (2007). Advances in psychology research, Volume 36. Nova Scotia Publishers, New York
• Thomsett, M. (2002). J.K. Lasser’s Buy, Sell, Or Hold: Manage Your Portfolio for Maximum Gain. John Wiley & Sons, USA
• Robinson, P.B., Stimpson, D., Heufner, J. & Hunt, H. (1991). An attitude approach to prediction of entrepreneurship. Entrepreneurship: Theory and Practice, 15, 13 to 31
• Miller, M. & Stoeckel, P. (2010). Client Education: Theory and Practice. Jones & Bartlett, Canada
• Vohs, K.; Baumeister, R.; Loewenstein, G. (2007). Do emotions help or hurt decision making?: a hedgefoxian perspective. Russel Sage Foundation, USA
• Hasse, J. (2010). Perfectly Able: How to Attract and Hire Talented People with Disabilities. Lighthouse International, USA