The development and empirical evaluation of a client/investor risk-tolerance model

Swart, Kate (2016-12)

Thesis (MCom)--Stellenbosch University, 2016.


ENGLISH ABSTRACT: Risk-Tolerance is an influential individual differences factor that determines the composition of financial portfolios that are optimal regarding the risk and return for the investor. At the heart of the financial services sector lie competent financial advisors. The foundation of any financial plan requires a thorough assessment of the Risk-Tolerance of the client/investor. Relying primarily on demographic and socioeconomic factors as predictors of Risk-Tolerance could undermine the ability of the financial advisor to accurately gauge the baseline degree of Client Risk- Tolerance. This may lead to wrongfully matching a client’s objectives with the financial plan, which could result in various costly effects. The successful advisor is one who realises that an understanding of the individual he/she is dealing with is just as important as a thorough understanding of the technical aspects of investments and the basic nature of investment decision-making. However, since there is no neatly packaged one-size fits all product, the service remains largely dynamic in nature – one that needs due consideration to each individual investor’s personal circumstances and preferences. It is argued that the most prudent approach to delivering sound investment advice would rely on the financial advisor’s ability to assess and integrate two distinct sets of data pertaining to overall Client/Investor Risk-Tolerance, that is, the combination of the client’s objective risk-tolerance (i.e. selected demographic and socioeconomic variables) as well as his/her subjective risk judgment (i.e. selected personality and emotion regulation variables) assessment. This research study aimed to determine how personality and emotional self-regulation variables (i.e. subjective risk judgment), as well as demographic and socioeconomic variables (i.e. objective risk-tolerance) could be combined in a conceptual model to differentiate amongst different levels of Client/Investor Risk- Tolerance. A cross--sectional dataset (n = 205) obtained from investors seeking financial advice, was used to fit the structural model via structural equation modelling (LISREL 8.8). Interaction effects were tested with moderated regression. The questionnaire included measures of personality, emotion regulation, risk-tolerance, as well as age, gender, education level and annual income. Both the measurement model (p-value for test of close fit = .592; RMSEA = .0475, NNFI = .937, CFI = .957, SRMR = .0591) and structural model (p-value for test of close fit = .0644; RMSEA = .0621, NNFI =.892, CFI = .919, SRMR = .0727) attained good fit. The results revealed empirical support for five of the 15 hypothesised paths contained in the structural model. More specifically, Sensation Seeking exerted a moderate positive direct influence on Risk- Tolerance. This result supported the argument that individuals with higher levels of self-reported Sensation Seeking, seeking financially risky experiences and stimulation by definition, will appraise risk as less threatening and anticipate arousal as more positive than their lower Sensation Seeking counterparts. The results further provided insight into the complexity of the dynamics underlying the different personality and emotion regulation variables contained in the model. For example, Extraversion was found to positively influence Sensation Seeking. This finding is in support of the notion that extraverts seek situations that provide them with higher levels of stimulation in order to maintain optimal levels of cortical arousal. Research has shown that extraverts are habitually in a state of lower cortical arousal, when compared to introverts. They tend to have higher sensory thresholds, and thus have smaller reactions to sensory stimulation, leading them to seek more thereof. Furthermore, Conscientiousness was found to positively influence Delay of Gratification. Consequently, it can be inferred that individuals who are strong willed, cautious and planful with a strong sense of self-discipline will naturally more likely display a superior ability to forego immediate gratification, in pursuit of achieving something of greater enjoyment or value at a future point in time. Further to this, the results revealed that Extraversion and Neuroticism exerted significant influences on Emotional Self-Management. Hence, it can be concluded that Extraversion predicts adaptive emotion regulation strategies, where individuals exhibiting this trait display the ability to preserve or savour positive emotions (i.e. Emotional Self-Management). In contrast to this, the results suggested that individuals higher on Neuroticism will more regularly use maladaptive emotion regulation strategies, and thus make poor use of adaptive strategies to repair negative emotions, resulting in less reported Emotional Self-Management. The moderated regression results revealed Gender to be a significant moderator in the Neuroticism – Risk-Tolerance, and Emotional Self- Management – Risk-Tolerance relationships, respectively. Secondly, empirical support for Income and Education as moderating variables emerged, indicating that Income and Education significantly moderated the effect of Emotional Self Management on Risk-Tolerance, respectively. The research results provided some insights into the relevant factors that can be used to judge Client/Investor Risk-Tolerance. A practical implication of the results is that this information can be used to classify investors into four different client categories or profiles that are clearly distinguishable in terms of their personal characteristics. Each profile raises unique needs warranting different actions on the part of the financial advisor. A successful financial advisor is able to transfer technical knowledge attained through comprehensive financial education into a coaching or counselling approach that enables the investor to make an investment decision that balances maximal gain (financially) with maximal security (emotionally). Investors should be encouraged to take the maximum amount of risk given their unique combination of objective and subjective characteristics. How the advisor goes about pursuing this requires an understanding of individual differences and other socio-demographic variables, and the ability to use these as a means of screening the client into the correct client category, and provide the associated supporting actions.

AFRIKAANSE OPSOMMING: Risikotoleransie is ’n invloedryke faktor van individuele verskille wat die optimale samestelling van ’n finansiële portefeulje vir die betrokke belegger se risiko en opbrengs bepaal. Bevoegde finansiële raadgewers maak die kern van die finansiëledienstesektor uit. Enige finansiële plan moet berus op ’n deeglike beoordeling van die kliënt/belegger se Risikotoleransie. Indien daar hoofsaaklik op demografiese en sosio-ekonomiese faktore as voorspellers van Risikotoleransie staatgemaak word, kan dit die finansiële raadgewer se vermoë ondermyn om die basislynomvang van die kliënt se Risikotoleransie akkuraat te peil. Dít kan daartoe lei dat die finansiële plan nie die kliënt se oogmerke korrek weergee nie, wat die betrokkenes op verskeie maniere duur te staan kan kom. ’n Suksesvolle raadgewer is een wat besef dat ’n begrip van die individu met wie hy/sy werk ewe belangrik is as ’n begrip van beleggings. Aangesien daar egter geen enkele, netjies verpakte produk is wat vir almal werk nie, bly die diens hoofsaaklik dinamies van aard en vereis dit behoorlike inagneming van elke individuele belegger se persoonlike omstandighede en voorkeure. Daar word aangevoer dat die verstandigste benadering tot grondige beleggingsadvies berus op die finansiële raadgewer se vermoë om twee verskillende datastelle met betrekking tot algehele Kliënt- /Beleggersrisikotoleransie te beoordeel en te integreer, naamlik die kombinasie van die kliënt se objektiewe risikotoleransie (d.w.s. uitgesoekte demografiese en sosioekonomiese veranderlikes) en sy/haar subjektiewe risiko-oordeel (d.w.s. uitgesoekte veranderlikes van persoonlikheid en emosionele regulering). Die doel met die navorsingstudie was om vas te stel hoe veranderlikes van persoonlikheid en emosionele selfregulering (d.w.s. subjektiewe risiko-oordeel) sowel as demografiese en sosio-ekonomiese veranderlikes (d.w.s. objektiewe risikotoleransie) saamgevoeg kan word in ’n konseptuele model om tussen die verskillende vlakke van Klient- /Beleggersrisikotoleransie te onderskei. ’n Deursneedatastel (n = 205) wat verkry is van beleggers wat finansiële advies ingewin het, is gebruik om die strukturele model deur middel van strukturele vergelykingsmodellering (LISREL 8.8) te pas. Interaksie-effekte is met gemodereerde regressie getoets. Die vraelys het metings van persoonlikheid, emosionele regulering, risikotoleransie sowel as ouderdom, geslag, opvoedingsvlak en jaarlikse inkomste ingesluit. Die metingsmodel (p-waarde vir goeiepassingstoets = .592; RMSEA = .0475, NNFI = 0.937, CFI = .957, SRMR = 0.0591) sowel as die strukturele model (p-waarde vir goeiepassingstoets = .0644; RMSEA = .0621, NNFI = .892, CFI = .919, SRMR = .0727) het ’n goeie passing opgelewer. Die resultate het empiriese steun vir vyf van die 15 veronderstelde paaie in die strukturele model opgelewer. Meer bepaald het Die Soeke Na Sensasie (“Sensation Seeking”) ’n matige positiewe direkte invloed op Risikotoleransie gehad. Hierdie resultaat staaf die argument dat individue wat self erken dat hulle groot sensasiesoekers is, en dus volgens die definisie finansieel riskante ervarings en stimulasie najaag, risiko as minder bedreigend sal ervaar en opwinding in ’n meer positiewe lig sal beskou as hulle eweknieë wat minder graag sensasie najaag. Voorts het die resultate ook verdere insigte in die komplekse dinamiek onderliggend aan die verskillende veranderlikes van persoonlikheid en emosionele regulering in die model gelewer. So byvoorbeeld het Ekstroversie (“Extraversion”) ’n positiewe invloed op Die Soeke Na Sensasie gehad. Hierdie bevinding ondersteun die gedagte dat ekstroverte omstandighede najaag wat hulle ’n hoër vlak van stimulasie bied ten einde optimale vlakke van kortikale opwinding te handhaaf. Navorsing toon dat ekstroverte gewoonlik in ’n toestand van laer kortikale opwinding verkeer vergeleke met introverte. Weens hulle geneigdheid tot hoër sintuiglike drempels en dus kleiner reaksies op sintuiglike stimulasie, het hulle méér daarvan nodig. Daarbenewens blyk Nougesetheid (“Conscientiousness”) ’n positiewe invloed te hê op Vertraagde Beloning (“Delay of Gratification”). Gevolglik kan daar afgelei word dat eiewillige, versigtige en georganiseerde individue met ’n sterker neiging om selfdissipline te handhaaf meer waarskynlik ’n natuurlike superieure vermoë sal hê om onmiddellike beloning te verbeur in die strewe na ’n groter of meer waardevolle beloning op ’n latere tydstip. Boonop het die resultate aan die lig gebring dat Ekstroversie en Neurotisisme (“Neuroticism”) ’n beduidende invloed op Emosionele Selfbestuur (“Emotional Self-Management”) uitoefen. Dus is die gevolgtrekking dat Ekstroversie waarskynlik gepaardgaan met emosionele aanpassingstrategieë, waar individue met hierdie eienskap die vermoë toon om positiewe emosies te koester of te geniet (d.w.s. Emosionele Selfbestuur). Daarteenoor het die resultate daarop gedui dat individue met hoër vlakke van Neurotisisme meer gereeld emosionele wanaanpassingstrategieë gebruik en dus swakker vaar met die herstel van negatiewe emosies, wat tot ’n laer aanmelding van Emosionele Selfbestuur aanleiding gee. Volgens die resultate van die gemodereerde regressie was Geslag ’n beduidende moderator in die verwantskap Neurotisisme – Risikotoleransie en Emosionele Selfbestuur – Risikotoleransie onderskeidelik. Tweedens het empiriese steun vir Inkomste en Opvoeding as Die navorsingsresultate bied insig in die tersaaklike faktore wat gebruik kan word om Klient-/Beleggersrisikotoleransie te bepaal. ’n Praktiese implikasie van die resultate is dat hierdie inligting gebruik kan word om beleggers in vier verskillende kliëntekategorieë of -profiele in te deel wat duidelik aan die hand van persoonlike eienskappe onderskei kan word. Elke profiel het eiesoortige behoeftes, wat bepaalde optrede van die finansiële raadgewer vereis. ’n Suksesvolle finansiële raadgewer is daartoe in staat om die tegniese kennis wat hy/sy deur omvattende finansiële onderrig opgedoen het toe te pas in ’n afrigtings- of raadgewingsbenadering wat die belegger in staat stel om ’n beleggingsbesluit te neem wat ’n balans handhaaf tussen maksimale gewin (finansieel) en maksimale sekerheid (emosioneel). Beleggers behoort aangemoedig te word om die maksimum hoeveelheid risiko te aanvaar op grond van hulle unieke kombinasie van objektiewe en subjektiewe eienskappe. Hoe die raadgewer te werk gaan om dít te bereik, vereis ’n begrip van individuele verskille en ander sosiodemografiese veranderlikes, en die vermoë om dit te gebruik om die kliënt in die korrekte kliëntekategorie te plaas en die gepaardgaande ondersteuning te bied. modereringsveranderlikes na vore gekom. Dit het getoon dat Inkomste en Opvoeding onderskeidelik die uitwerking van Emosionele Selfbestuur op Risikotoleransie beduidend modereer het.

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