HomeAnswerNotificationsCustomize Feeds
HOMEQUESTION
Does fear of losing, affect investors risk tolerance?
$0.00
2 ANSWERS

Yes, the fear of losing money could be the primary factor that affects an investor's risk tolerance.

In general, it is believed that spending habits are the main driver of risk tolerance, meaning that the more variation an investor is willing to accept in his spending, the higher the risk tolerance for investments. However, some experts also emphasize that no such relation exists between risk tolerance and spending habits. Rather, loss aversion is a much more accurate indicator of risk tolerance. The more averse, or fearful, to losing money an investor is, the lower their tolerance seems to be for taking risks in the stock market. Additionally, consumer sentiment also appears to help explain investor's risk tolerance, though not nearly as much as loss aversion.

There are three potential drivers of risk tolerance: loss aversion, changes in investor spending habits and changes in consumer sentiment levels. It is important for risk assessment instruments to measure loss aversion, especially during times when the stock market is performing poorly. Knowing how much investors are willing to risk at the worst of times is valuable for financial planners tasked with creating long-term investment plans.

Financial planners probably acquire more accurate information on client risk preferences when risk tolerance is assessed in a hot state when stock prices are falling, compared to a cold state when stock prices are rising. As it is well known that loss aversion is a key factor that drives risk tolerance, it is important for investors to take steps to reduce their loss averse tendencies. This includes viewing investment returns infrequently, as investors allocate a greater percentage of their portfolio to stocks if they view their returns on an annual, as opposed to monthly, basis.

Further, encouraging investors to view their portfolios in a holistic manner also will help reduce loss aversion. The financial planner's guidance can at least help increase investor certainty during periods of market turmoil.

$0.57
Reply

Yes, and this is not only true for investments of money or any type of financial investment, but it is also true for any situation where percentage of lost is higher than one can afford.

This is mostly more common in new investors, but with time and experience, most of the people learn to control it and this gives them more power over their decisions.

$0.00
Reply