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Personality and Risk Tolerance

Running head: Personality and Risk Tolerance

Matt Stewart Business Psychologist Psychological Consultancy Limited 8 Mount Ephraim Tunbridge Wells Kent TN4 8AS +44 01892 559540 Geoff Trickey Managing Director Psychological Consultancy Limited 8 Mount Ephraim Tunbridge Wells Kent TN4 8AS +44 01892 559540

Type of software used: Microsoft Word 2008 for Mac


Personality and Risk Tolerance

Abstract This study aimed to investigate the relationship between risk and personality. Seventy participants completed the Risk-Type Compass™ personality measure and the Domain-Specific Risk-Taking (DOSPERT) scale for adult populations (Blais and Weber, 2006), measuring risk attitudes in five areas. Results of a correlation analysis found the personality scale Calm:Emotional (characterised by resilience, high selfesteem, confidence and calmness) to be positively related to financial, recreational and social risk tolerance, as well as the total risk tolerance score. The Daring:Measured personality scale (characterised by a desire for variety, excitement, spontaneity and flexibility) was related to financial, health & safety, recreational, social and the total risk tolerance variables. Based on these findings, a new personality type theory of risk tolerance is suggested to help financial advisers and to simplify the use of personality testing as an aid to ascertaining client risk tolerance. Keywords: Risk Tolerance, Personality, Five Factor Model, Risk-Type Compass, Risk Assessment


Personality and Risk Tolerance Personality and Risk Tolerance For reasons of compliance and client relationships, it is important for financial advisers to ascertain their clients risk tolerance using an assessment measure prior to embarking on any investment strategy. Malkiel (1996) notes that assessing an individual’s capacity to handle risk is vital to the successful planning of their financial investments. Some authors have even suggested that assigning individuals with low risk tolerance investment options that are too risky for their natural temperament can have devastating effects on the economy if these risky investments are sold en masse when panic sets in (Pan and Statman, 2009; Sjoberg and Engelberg, 2009). Aside from these wider implications, assigning an investor shares that are not consistent with their risk tolerance is likely to lead to disappointment and regret and have detrimental effects on the adviser/investor relationship (Moreschi, 2005). Given its importance, it is no surprise that the examination of factors thought to influence risk tolerance has received considerable attention in the academic world. The majority of research has focused thus far on biographic and socioeconomic predictors of risk tolerance. This article examines a less well-researched area, examining the extent to which an individual’s personality determines their risk tolerance. Personality and Risk Tolerance Personality is one of the most researched areas of psychology and, in addition to having wide ranging predictive qualities, personality assessments have the benefit of not discriminating between racial or ethnic groups and are easy to administer using self-report questionnaires. Personality clearly has an important part to play in the applied risk tolerance domain, especially in the light of new research that has found evidence for a genetic relationship between personality and risk tolerance (Kuhnen and Chiao, 2009).


Personality and Risk Tolerance Furthermore, people often talk about risk tolerance in terms of personality characteristics (e.g. “Client X worries about the potential losses that may be incurred with high risk investments”, or “ Client X is particularly optimistic when it comes to taking chances with their money”), so it could be argued that from a content point of view, risk tolerance by definition is an area of personality.  Additionally, unlike some traditional risk tolerance measures, personality questionnaires do not require the respondent to understand financial terminology, make forecasts or self-report their own risk tolerance levels. Whilst there are many benefits to using personality assessments, perhaps the most important over traditional risk tolerance measures is that personality is highly stable across time and in different situations (Hogan, 2007), so measuring risk tolerance through personality would provide a long term indication of a client’s ‘hard wired’ appetite for risk. It would seem that there are two strata to risk tolerance. Firstly, a personality based strata, close to basic temperament and to a degree, hard wired. Secondly, an attitude to risk strata, influenced by personal circumstances and experience with financial investments, so that, within limits, actual risk tolerance levels may be moderated by these factors. This is the model for the Risk-Type Compass™, described further below. Research on personality and risk has centred around a globally recognised consensus about the structure of personality known as the Five Factor Model or FFM (Barrick and Mount, 1991). The FFM describes personality using five broad themes, the ‘primary colours of personality’ described below. Openness to Experience. The degree to which a person is inquisitive, imaginative and needs intellectual stimulation, change and variety.


Personality and Risk Tolerance Conscientiousness. The degree to which a person is organised, systematic attentive to detail and willing to comply with rules and conventions. Extroversion. The degree to which a person is outgoing, gregarious, and assertive and seeks excitement and the company of others. Agreeableness. The degree to which a person is sympathetic, concerned what others think of them and needs pleasant and harmonious relationships. Emotional Stability. The degree to which a person is calm, self-assured, optimistic and consistent in their moods rather than anxious and self-doubting. Neuroticism, referred to elsewhere, is just the reverse of Emotional Stability. Whilst a few studies have found a significant relationship between Agreeableness and risk tolerance (Kowert, 1997; Nicholson, Soane, Fenton-O’Creevy and Willman, 2005), the majority of studies have focused on Neuroticism, Conscientiousness, Openness to Experience and Extroversion. Neuroticism. The relationship between Neuroticism (or Emotional Stability) and risk tolerance is one of the most extensively researched areas in this domain, with a number of studies reporting that high Neuroticism, or Neuroticism subthemes are significantly related to lower financial risk tolerance (Grable and Joo, 2004; Haleblian, Markoczy and McNamara, 2004; Mayfield, Perdue and Wooten, 2008; and Nicholson et al., 2005) or lower general risk tolerance (Kowert, 1997). Those with high levels of neuroticism are likely to worry more about the consequences of losing money than the gains that could be made and will find investment a more risky process than most other people. They are also likely to be more upset when risks don’t pay off. Conscientiousness. A number of authors have found lower Conscientiousness scores to be significantly associated with having a higher financial risk tolerance


Personality and Risk Tolerance (Hunter and Kemp, 2004; Nicholson et al., 2005; Pan and Statman, 2009) or general risk tolerance (Kowert, 1997). Conscientiousness is characterised by a need for conformity and control (Hogan and Ones, 1997) and high scorers should be less tolerant of uncertainty, change and innovation and so will be less willing to engage in risky ventures (Nicholson et al., 2005). Openness to Experience. Openness to Experience concerns a preference for experimentation with new activities and being comfortable with change and variety, so it is no surprise that research has reported strong links between this FFM factor and financial risk tolerance (Hunter and Kemp, 2004; Mayfield et al., 2008; Nicholson et al., 2005; Pan and Statman, 2009) or risk in general (Kowert, 1997). High scores are more comfortable with uncertainty and will actively seek out risks and embrace highrisk investments. Extroversion. Some authors have found correlations between general measures of Extroversion and of financial risk tolerance (Nicholson et al., 2005; Pan and Statman, 2009). This finding can be explained by research suggesting that an Extrovert’s need for stimulation is likely to result in an increased desire for sensation seeking (Eysenck 1973), making them more likely to take risks (Nicholson et al., 2005). It may not be the sociability element of Extroversion that is important for risk tolerance, but the specific characteristics concerning excitement or sensation seeking. A number of studies have identified these characteristics to be associated with both financial risk tolerance (Harlow and Brown, 1990; Hunter and Kemp, 2004) and general risk tolerance (Kowert, 1997; Zuckerman et al., 1964; Zuckerman and Kuhlman, 2000). The current study aims to examine the relationship between ‘risk tolerance personality’ and risk tolerance as assessed by an attitudinal measure.


Personality and Risk Tolerance Measuring Risk Tolerance Personality Risk tolerance personality is assessed through two composite personality scales measured in a personality based risk tolerance assessment, the Risk-Type Compass™. The first scale is Calm:Emotional (C:E), which is a measure of Emotional Stability. High scorers are likely to have the confidence and positive outlook to take risks, focusing more on the potential positive outcomes over the negative consequences of failing. Conversely, lower scorers are likely to be less confident that risks will pay off and will worry what the consequences will be if they are not successful. As a result they will shy away from risk taking. Therefore, the first hypothesis tested in this study is that the Calm:Emotional variable will be positively related to risk tolerance. The second personality scale in the study is Daring:Measured (D:M), which is predominantly a measure of Conscientiousness but also includes both the variety seeking element of Openness to Experience and the sensation seeking aspect of Extroversion. High scorers are more flexible and less concerned with needing to plan out every detail of a project than low scorers and will therefore be more comfortable with unpredictable, or risky situations. They are likely to be engaged by variety and new ventures and will actively seek out exciting and more risky activities. Low scorers on the other hand will want to minimise exposure to risk through careful planning and preparation and generally plan risk out of their lives. Their lack of flexibility and need for control means that they will not be daring or pursue risky ventures and their desire to conform means that they will be less inclined to embark on risky ventures for fear of breaking the rules. Additionally, they are not particularly interested in variety and novelty and as such will not actively seek out more extreme


Personality and Risk Tolerance or risky activities. Therefore, the second hypothesis tested in this study is that Daring:Measured will be positively related to risk tolerance. Measuring Risk Tolerance Measuring risk tolerance itself is a complex area (Trickey and Stewart, 2010) and a number of factors were considered concerning the risk tolerance measure to be employed in the study. Research indicates that whilst individuals may have a general personality based level of risk tolerance, their attitude to risk may be more robust for some types of risk than for others. For example, it doesn’t necessarily follow that someone who enjoys risky recreational activities will also want to take risk with their money. The implications of the multidimensionality of risk taking for financial advisers is that whilst clients may describe themselves as risk taking, on closer inspection this may be restricted to only certain types of risk, perhaps not financial. Studies by Weber, Blais and Betz (2002) and Blais and Weber (2006) suggest that there are five main risk-taking domains, which will be used as the measure of risk tolerance in the current study. The main areas of risk attitude measured are: financial, health & safety, recreational, ethical and social. While the primary focus is on financial risk, the study also aims to investigate the possible relationships between personality and other domains of risk, to see which areas were most closely linked. Method Participants The participant sample consisted of 70 managers and professionals, of which 56% were female and 44% were male, with ages ranging from 22 to 70 and a mean age of 39. Participants were recruited via an advertisement in a newsletter and were all based in the United Kingdom, predominantly working either in the HR or Occupational Psychology sectors or were financial advisers at wealth management


Personality and Risk Tolerance organisation HFM Columbus. All participants were informed of the purpose of the study, but were naïve concerning the specific hypotheses. Measures Risk Tolerance – Personality. Personality was assessed through the RiskType Compass™ questionnaire, measuring the elements of the Five-Factor Model scales that had been identified as being key to risk tolerance: Conscientiousness, Neuroticism, Openness to Experience and Extroversion. These four elements were arranged in two main conceptually orthogonal ‘risk personality scales’, termed Calm:Emotional and Daring:Measured. The alpha coefficients for both scales were well above the threshold for good internal reliability of .70 (Nunnally and Bernstein, 1994), with values of .86 for Calm:Emotional and .83 for Daring:Measured. Questions were composed of a personality statement (e.g. “Nothing really throws me off balance”) and respondents were asked to state the extent to which they agree using a 6 point Likert scale ranging from “Disagree”, 0, to “Agree”, 5. Risk Tolerance – Attitudes. Self reported risk tolerance was assessed via a risk attitudes questionnaire, the Domain-Specific Risk-Taking (DOSPERT) scale for adult populations (Blais and Weber, 2006),  which looks at the following five main domains of risk taking: ethical, financial, recreational, social and health & safety. Since its creation this tool has been validated in a number of contexts, using a variety of populations (Weber, 2009). It has been found to have good internal reliability, with alpha coefficients for each domain ranging from .74 for ethical and health & safety to .83 for financial and social. The questionnaire uses a 7 point Likert scale, with questions that ask participants to rate the likelihood of engaging in particular risky behaviours (e.g. “Investing 5% of your annual income in a very speculative stock”) on a scale from 1 (“Extremely Unlikely”) to 7 (“Extremely Likely”). For the purposes of


Personality and Risk Tolerance this study, a total risk tolerance variable was also created by summing scores on each of the five risk attitude domains. Higher scores on each domain are indicative of a greater risk tolerance for the behaviours associated with that particular area. Procedure Participants completed the personality questionnaire using an online assessment system and the risk attitude questionnaire was emailed to participants in the form of a word document. All participants received a written report based on their personality questionnaire results and risk attitude reports were also given to respondents upon request. Results Descriptive statistics and bivariate correlations between the personality scales (reflecting ‘risk tolerance personality’) and the six self reported risk tolerance variables were ascertained in order to test the study hypotheses. Data screening was carried out prior to the analysis. No univariate outliers were detected (z > ± 3.29; Tabachnick and Fidell, 2007) and no multivariate outliers were identified using the Mahalanobis distance method (P < 0.001). All study variables were found to be normally distributed, with the exception of the ethical and financial risk tolerance variables, with skew statistics of .78 and .62 respectively. Logarithmic transformations were carried out to reduce skew to -.04 for the ethical variable and .00 for the financial variable. Descriptive statistics Means and Standard Deviation (S.D.) statistics for all study variables were calculated and the values are displayed in Table 1. Calm:Emotional scores run on a scale ranging from 0 to 200, whilst Daring:Measured scores range from 0 to 160. The attitude variable scale scores run from 6 to 42, whilst the Risk Tolerance Total scores range from 30 to 210. Mean scores for the risk domains show some interesting 10  

Personality and Risk Tolerance patterns. It seems that the sample generally were more comfortable with recreational risk (mean = 19.37) and least comfortable with the risks in the ethical domain (mean = 12.86). Table 1. Descriptive statistics for all study variables (n=70). Variable Mean S.D. Personality Scales Calm:Emotional 116.93 20.46 Daring:Measured 82.71 17.18 Attitude Variables Ethical Financial Health & Safety Recreational Social Risk Tolerance Total

12.86 17.69 18.29 19.37 31.16 99.36

4.94 6.08 6.06 8.85 5.99 21.15

Correlations The Calm:Emotional and Daring:Measured personality scales were entered into a correlation matrix alongside the five risk domains and the total risk tolerance score. The results are presented in Table 2 below. See appendix for the full correlation matrix. Table 2. Correlations for the personality and risk attitude variables measured in the study (N = 70). Ethical Financial Health & Recreational Social Total Safety
















*p<0.05. **p<0.01. ***p<0.001. Results from this analysis support the hypotheses that the two personality scales are predictive of self-reported risk tolerance in a number of the domains.


Personality and Risk Tolerance Financial Risk Tolerance. As predicted, both the Calm:Emotional (r = .31, p<0.01) and Daring:Measured (r = .44, p<0.001) scales were found to be significantly related to financial risk tolerance, so that financial risk tolerance increased as scores on the personality scales increased. Other  Findings   Whilst Calm:Emotional was found not to be significantly related to Health & Safety risk tolerance, Daring:Measured was ( r = .33, p<0.01). As hypothesised, both Calm:Emotional (r = .39, p<0.01) and Daring:Measured (r = .46, p<0.001) were found to be significantly related to the self reported recreational risk tolerance variable. Calm:Emotional (r = .47, p<0.001) and Daring:Measured (r = .59, p<0.001) were both associated with social risk tolerance, supporting both study hypotheses. Whilst Calm:Emotional was not significantly associated with ethical risk tolerance, there was a marginally significant association between Daring:Measured and ethical risk tolerance (r = .22, p= .07). Finally, Daring:Measured was found to be significantly related to overall risk tolerance (r = .64, p<0.001), with Calm:Emotional also related to the total risk tolerance variable (r = .31, p<0.01). Overall Findings Results support that notion that personality and self-reported risk tolerance in a number of domains are linked. Examination of the correlations show the Calm:Emotional scale to be most effective at predicting self-reported social risk tolerance, followed by recreational risk tolerance, financial risk tolerance and the total risk tolerance variable. The Daring:Measured scale was overall slightly more effective at predicting self-reported risk tolerance, being most associated with the


Personality and Risk Tolerance total risk tolerance variable, followed by social, recreational, financial and health & safety risk tolerance. Discussion The results provide evidence for the relationships between the personality scales Calm:Emotional and Daring:Measured and risk tolerance as assessed by a selfreported attitudinal measure. Both study hypotheses were supported, so that Calm:Emotional was found to be positively related to financial, recreational and social risk tolerance, as well as the total risk tolerance score. Results show Daring:Measured to be positively related to financial, health & safety, recreational, social and the total risk tolerance variables. There was one surprising finding. Looking at the correlations between selfreported risk tolerance and the personality scales, ethical risk tolerance was not associated with Calm:Emotional and only marginally significantly correlated with Daring:Measured (r = .23, p = .06). As this is the first study to examine the association between personality and ethical specific risks it would be unwise to draw conclusions that these two personality factors do not influence risk in this area. However, it may be that the ethical behaviours are more concerned with morals and values than with risk tolerance. Doubtless, future research will cast further light on this issue. Study Limitations and Avenues for Future Research Perhaps the biggest limitation with the current study is that the measure of risk tolerance used was subjective and self rated rather than objective. However, it is questionable whether it is possible to measure risk tolerance objectively. Another option would be to adopt a more experimental approach, taking measures of financial risk tolerance early on in the investment process and then examine which level of


Personality and Risk Tolerance investment options are preferred before any advice is given. Other avenues could explore the relationship between personality and attitude measures of risk tolerance currently being used in the financial sector. Future research should therefore look at investigating links between personality and risk tolerance in an investment setting. Finally, research could investigate the mediators, or mechanisms, by which personality affects risk tolerance. Implications for Financial Advisers The results have important implications for financial advisers. They highlight the possibility of using personality measures to ascertain a client’s risk tolerance levels, alongside, or perhaps as an alternative to more traditional measures. One of the challenges financial advisers may face in adopting the personality approach to risk tolerance is learning how to interpret their client’s personality profiles. Whilst there may be avenues for training in this area, a more flexible approach may be to produce personality reports specifically for financial advisers. The Risk-Type Compass™ personality questionnaire aims to do this, with output placing individuals into one of eight easy to understand personality ‘types’, ranging in levels of risk tolerance and each associated with different personality characteristics that affect the way an individual handles risk. The questionnaire also incorporates attitudes to risk, measuring any current moderating effect these may be having on the client’s risk tolerance levels. The Risk-Type Compass™ graphic depicting the eight types is displayed below in Figure 1. Each type is formed using different combinations of the Calm:Emotional and Daring:Measured scales. The graphic is a spectrum of risk personality with facing types being opposites in terms of personality characteristics and the neighbouring types being most closely associated. The eight types are also


Personality and Risk Tolerance either ‘factor types’ or ‘complex types’. The four factor types, Intense, Composed, Prudent and Carefree are dominated by either high or low scores on one of the conceptually orthogonal scales, Calm:Emotional and Daring:Measured. The four complex types, Wary, Deliberate, Spontaneous and Adventurous are made up of interactions between high and low scores on the two personality scales. Types range from the most risk tolerant ‘Adventurous’ at the bottom of the Risk-Type Compass™, to the least risk tolerant type, ‘Wary’, at the top.

Figure 1. The Risk-Type Compass™ depicting the eight Risk Types and a score indicated with a red marker. The definitions of the eight Risk Types are below: Spontaneous. Impulsive and excitable, they enjoy the spontaneity of unplanned decisions, but worry about their actions. Intense. Anxious, alert to any risk of threat to their precarious equilibrium. Passionate and self-critical by nature, they take it personally when things don’t work


Personality and Risk Tolerance out. Wary. Self-disciplined and anxious about risk, they are organised but worried and unadventurous. They put security at the top of their agenda. Prudent. Very self-controlled and detailed in their planning, they have a strong preference for tradition and the familiar. Deliberate. Self-confident, systematic and compliant, they experience little anxiety and tackle risk and uncertainty in a business-like and unemotional way. Composed. Cool headed, calm and unemotional, but at the extreme may seem almost oblivious to risk and unaware of its effect on others. Adventurous. Impulsive and fearless. They combine a deeply constitutional calmness with impulsivity and a willingness to challenge tradition. Carefree. Impulsive and unconventional, not good at careful preparation, they often seem vague about their intentions. Their impatience and impulsiveness can lead to hasty and imprudent decisions. Whilst personality gives a good baseline level of an individual’s risk tolerance, it’s also evident that factors such as an individual’s experience with risk and their personal circumstances are also likely to have an impact. For example, regarding financial risk, someone with experience with investments may be more inclined to take risks than a novice. Likewise, someone with a high income may be more likely to take higher risk financial investments, as they have a larger pool of resources available to soften the blow of any losses. These factors are likely to be indicated via an individual’s current attitude to risk and taken alongside their ‘risk tolerance personality’, can be used to form a unified prediction of their risk tolerance (see figure 2).


Personality and Risk Tolerance

Figure 2. The proposed model of Risk Tolerance, incorporating both strata of risk tolerance, Risk Type (personality) and Risk Attitude. In summary, this study supports the notion that risk tolerance is strongly associated with personality. Not only is personality important for financial risk tolerance, but it can also predict risk tolerance in other areas. In the context of financial planning, advisers should aim to incorporate a personality-based measure of risk tolerance as an alternative or alongside traditional measures.


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Personality and Risk Tolerance Appendix Bivariate correlations for the personality and risk attitude variables measured in the study (N = 70). Variable 1 2 3 4 5 6 7 8 1.Calm:Emotional 2.Daring:Measured 3.Ethical 4.Financial 5.Health&Safety 6.Recreational 7.Social 8.Risk Tolerance Total

.19 -.16 .31** -.10 .39** .47*** .31**

.22 .44*** .33** .46*** .59*** .64***

.05 .41*** .09 .26* .47***

*p<0.05. **p<0.01. ***p<0.001.


.13 .46*** .37** .63***

.27* .25* .60***

.50*** .79***



Personality and Risk Tolerance