Portfolio Management
Unit – II
Session No. 10
Topic: Investor Characteristics
Session Plan
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Recap the Previous Session
What is Traditional Finance?
What is Behavioral Finance?
What is personality typing?
Summarizing and Q & A
Recap
• What are the fundamental factors influencing the investors
characters?
• Why “Self-made” investors may have greater familiarity with risk
taking?
• How an individual differentiate the size of Portfolio to meet his
future needs?
• Why the investors’ ability to accept risk should gradually decline
through his life time?
Psychological Profiling
• Focus on psychological influences process by which an individual establishes
his or her investment preferences.
• Individual brings to the investment decision making process an objective set of
– financial circumstances,
– goals, and constraints
• Behavioral patterns and personality characteristics often also play an important
role in setting individual risk tolerance and return objectives.
• Psychological profiling, sometimes referred to as
• Personality typing,
• Bridges the differences between traditional finance (economic analysis of objective
financial circumstances).
Psychological Profiling
• Traditional Finance
• Much of the standard history of economic and financial theory rests on the
philosophy that financial market participants are rational.
• Information-based investors
• Objectives that maximize the expected utility of wealth.
• In models of traditional, or standard, investment decision making, investors
are assumed to:
 Exhibit risk aversion - prefer the investment with the lowest volatility
 Hold rational expectations - forecasts will reflect all relevant information
 Practice asset integration - investors choose among risky investments
Psychological Profiling
• Behavioral Finance
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Individuals approach/behavior in uncertain situations.
In these studies, psychological considerations appear to play an important role
Guiding investor behavior, especially during periods of stress.
These decision-making models attempt to incorporate the principles of
behavioral finance, in which individual investors are recognized to:
 Exhibit loss aversion - investors evaluate opportunities in terms of gain or loss rather than
in terms of uncertainty with respect to terminal wealth
 Hold biased expectations - misplaced confidence in one’s ability to assess the future
 Practice asset segregation - investment choices individually
Psychological Profiling
• Personality Typing
• Classification of Investors by their personality dimensions,
socioeconomic background, personal experience, and current
wealth status.
• Personality typing understand through survey and scenario analysis.
• It helps the investment advisers to better understand the behavioral
drivers
– individual’s goal-setting, asset allocation, and risk-taking decisions, Client
management
Psychological Profiling
• The critical question that must be answered with respect to client
questionnaires is whether the results consistently assign respondents to risktaking and decision-making styles that explain the respondents’ actual behavior.
• A stratified random sample involves independent sampling from subgroups
that, when combined, represent a population’s overall characteristics.
• Results from the sample questions (each question addresses a specific category
of investor risk tolerance and decision-making style) are tabulated and used to
identify systematic differences in decision-making style and risk tolerance.
• Based on these measures, four investment personality types are established.
• Correlation analysis can be used to assess a questionnaire’s usefulness. By
assigning ranks to personality types (1 = Methodical, 2 = Cautious, 3 =
Individualistic, 4 = Spontaneous)
Psychological Profiling
Psychological Profiling
Psychological Profiling
• Cautious Investors
• Cautious investors are generally averse to potential losses.
• This aversion may be a consequence of their current financial situation or of
various life experiences, but most exhibit a strong need for financial security.
• Cautious investors usually desire low-volatility investments with little potential
for loss of principal.
• Although these individuals generally do not like making their own decisions
• Cautious investors dislike losing even small amounts of money.
• They often miss opportunities because of over analysis or fear of taking
action.
• Their investment portfolios generally exhibit low turnover and low volatility.
Psychological Profiling
• Methodical Investors
• This group relies on ‘‘hard facts.’’
• Methodical investors may intently follow market analysts or undertake research
on trading strategies.
• Even when their hard work is rewarded, they typically remain on a quest for
new and better information.
• Their reliance on analysis and database histories generally keeps them from
developing emotional attachments to investment positions, and their discipline
makes them relatively conservative investors.
Psychological Profiling
• Spontaneous Investors
• Spontaneous investors are constantly readjusting their portfolio allocations and
holdings.
• With every new development in the marketplace, they fear a negative
consequence.
• Although spontaneous investors generally acknowledge that they are not
investment experts, they doubt all investment advice and external management
decisions.
• Spontaneous investors are quick to make decisions on investment trades and
generally are more concerned with missing an investment trend than with their
portfolio’s level of risk.
Psychological Profiling
• Individualist Investors
• This group has a self-assured approach to investing.
• Individualists gain information from a variety of sources and are not averse to
devoting the time needed to reconcile conflicting data from their trusted
sources.
• They are also not afraid to exhibit investment independence in taking a course
of action.
• Individualist investors place a great deal of faith in hard work and insight, and
have confidence that their long-term investment objectives will be achieved.
Psychological Profiling
Summarizing Q & A
• What is Traditional Finance?
• What is the consequence of traditional assumptions on individual
economic behavior?
• What is Behavioral finance?
• How individuals are taking decisions based on behavioral finance?
• How the personality typing bridges the difference between
traditional finance and behavioral finance?
Team Assignment
The students are asked to prepare a Personality typing
questionnaire based on decision making style and risk tolerance
to identify the four different type of investors.