Personality factors influencing risk-tolerance

In 1998, Wong and Carducci investigated the extent of which personality factors could determine financial risk taking in everyday money matters. They concluded that persons fitting the Type A personality trait tended to take greater risks than those more closely aligned with the Type B personality profile. They suggested that socioeconomic factors, such as income, might have played a part in explaining their findings. It was found that Type A individuals took greater financial risks than Type B individuals, providing evidence that personality factors influence financial risk tolerance [Masters R, (1989)]. The purpose of this research was to extend the investigative line of inquiry, as initiated by Carducci and Wong, regarding risk taking in everyday money matters by examining socioeconomic, demographic, and attitudinal characteristics that may be used either individually or in combination as determinants of financial risk tolerance.

Figure 1: Personality Types
Figure 1: Personality Types, Source: Website, Examiner.com

 

Maginn et al (2007) divides investment risk personality types into four primary types: Cautious, Methodical, Spontaneous and Individualistic (Website, examiner.com). This is demonstrated in the figure above. Cautious investors are generally averse to risk and need strong financial security, hence have the tendencies to earn a limited income. Methodical investors follow market trends and analyses, “hard facts” and research trading statistics; they undertake thorough research before investing. Individualist investors are those who do not shy away from taking risks independently, thus are most self-assured. Lastly, spontaneous investors are the quickest in investment decision-making and are more concerned with missing trends than the overall risk of their portfolio. According toCrosby(Examiner.com), most investors exhibit more than one investment types.

Cooper (1981) classifies the concept of personality into two divisions- the macro level i.e. the current political and economic conditions or regional specifics and the micro level, i.e. the ‘soft’ factors like abilities, personality traits, perceptions and attitudes, etc. and  ‘hard’ factors such as socio-demographic characteristics. Similarly, Weigel (2005) asserted that the psychological factors of individuals influence their business decisions as well as their ability to actively react to the changes in the environment. Entrepreneurial decisions and other decisions regarding businesses such as investment decisions are influenced by the individual’s personality. For instance, Schumpeter (1934) lists certain attributes of entrepreneurs, calling them ‘extraordinary individuals’: they defy conventions, originate innovations and endorse creative destruction.

In the recent researches, it’s found that psychological trait such as intelligence, personality, attitudes, aptitude, and values have a relationship between financial risk tolerances, as it resembles such traits in general. This interesting point of view was found out by Carducci & Wong 1998; Wong & Carducci 1991 and Zuckerman 1983). A trait can be defined as a distinguishable, proportionately lasting way in which one person varies from another. The significance of personality factors in financial risk taking was examined by Carducci and Wong in 1998 [Nunnally, J.C. (1967)].

Shoda, Mischel and Wright in 1994 arrived at the conclusion that individuals have steady behavioral tendencies according to different psychological situations. Mischel (1968) contradicts the trait theory of personality (earlier explained in context of Carducci and Wong, 1998) as a determinant of risk tolerance. He asserts that an individual’s behavior is relatively situation specific and highly variable. He concludes that individuals possess stable behavioral tendencies based on certain types of psychological situations.

A hypothesis was made stating financial risk tolerance in business is not a stable psychological quality (quite elastic), and knowledge in finance can easily alter one’s attitudes and risk tolerance. In other words, people with a high knowledge of finance will be more into it and will be able to draw their inferences to get maximum result and thus high level of risk tolerance. It’s quite clear that, in order to examine the depth of the relationship between financial knowledge and risk tolerance more and more studies should be done. In 1997, Powell and Asnic came up the fact that risk tendency is a general quality and mentioned about the distinguishable gender differences in financial risk tolerance. Meanwhile they also suggested the importance of assessing the robustness of the risk preference as a general quality or trait [Howard, W.H., (1997)].

There was another concept called changing personality of an individual. Personality might change as changes in people occur. This is because personality is being affected by nurture.

There are different classifications of personality in our day to day life. Adjectives of personality given by common people include curious, responsible, reckless, grumpy, shy, friendly, etc. Allport and Odbert in 1936 mentioned that there exist about 4500 such adjectives for the term personality. Factor analysis is used by personality researchers for aggregating personality traits into factors.  The various personality models existing today make use of 2 to more than 5 factors. Personality traits are aggravated into 5 factors called the five factor model. It includes openness, neuroticism, extraversion, agreeableness and conscientiousness [Lester, L.F., & Bombaci, D.H. (1984)].

While financial decision-making requires personality traits like creativity, imagination, self-efficacy, internal locus of control etc., traits like risk aversion and agreeableness indicate the typical non-entrepreneurial type (Shane, 2003).

Weigel (2005) proposed a model to establish the impact of personality on financial risk taking, called as the MBTI model. According to this model, all individuals’ functioning related to financial issues consists of fundamental options like their personality type: Extrovert/ Introvert; Intuitive/ Sensing; Feeler/ Thinking and Perceiving/ Judging.

He goes further to assert that due to tremendous changes in production, gobalisation and competition, technology, infrastructure and risk management strategies, investors are taking time in adjusting to these changes which reflects on their investment decisions.

Personality traits have also been classified on the basis of gender (Caliendo et al, 2009; Wilson et al, 2007). Researchers state that women are more risk-averse than men which affect their risk-taking ability. Similarly their psychological characteristics differ as women are more inclined towards autonomy, adaptability and self-actualization and less towards profits.

Reference

  • Nunnally, J.C. Psychometric Theory, 1967.
  • Howard, W.H., Brinkman, G.L., & Lambert, R. Canadian Journal of Agricultural Economics, 1997
  • Lester, L.F., & Bombaci, D.H. Human Factors, 1984.
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