Grace Piggott
Junior
University of Wisconsin Stout
Advisor Dr. Fassil Fanta
Risk tolerance is defined as the degree of variability in investment returns that an individual is willing to
withstand.
High risk tolerance: Investors are more aggressive in their investments. They are happy with higher risk
levels in exchange for possibly making higher returns. They are also willing to take higher losses
believing they will make more in the long run.
Low risk tolerance: Investors are less aggressive in their investments. They tend to feel more
comfortable knowing their low risk investments could equate to lower returns.
Most people are not willing to take above average risks to obtain above average returns on their
investments (Avery & Elliehausen, 1986).
Why does this matter?
Knowing what socioeconomic characteristics affect one’s risk tolerance would allow for financial
advisors and others to understand why some people are more or less cautious about
investments than others. Having this information will likely allow financial advisors to give more
accurate investment advice based off an investors characteristics.
What socioeconomic characteristics determine
the risk tolerance of individual investors?
Hypothesis: Individual investors risk tolerance is influenced by socioeconomic
characteristics such as income, education, and family structure.
Benefits to knowing what characteristics impact risk tolerance:
1. Allows for financial advisors and economists to gain a better prospective on the
matter.
2. Allows financial advisors to give more accurate investing advice.
3. Gives individuals a better understanding of how their socioeconomic characteristics
may impact their investment options.
»
In the Federal reserve bulletin Bricker et al. (2012) stated, “Family’s finances are affected
by both their own decisions and the state of the broader economy.”
»
Sulaiman (2012) stated, “An investors ability to handle risk may be related to
demographic features such as age, gender, marital status, occupation, income, time
horizon, liquidity needs, portfolio size, investment knowledge, and attitude towards price
fluctuations”.
»
Grable and Lytton (1998) however felt that assuming someone’s age impacts their risk
tolerance could create potential problems.
»
Both Sudaiman (2012) and Grable and Lytton (1998) said that it is commonly believed
men will take more risks than woman. Women tend to live longer, tend to have lower
lifetime earning potential, and are more likely to be single parents than men so Grable
and Lytton (1998) felt that woman had a larger need to increase their risk in order to
assure they could meet their financial needs.
»
Finke and Huston (2003) felt that those with higher education tend to have a higher risk
tolerance because they commonly have more financial knowledge.
» The data I used for this research was collected
from consumer finance surveys between 1992
and 1998. The dollar amounts were all
converted to thousands 2010 dollars.
» I also reviewed data from the Federal Reserve
Bulletin titled Changes in US family finances
from 2007 to 2010: Evidence from the
consumer finance published in June of 2012.
Variables
Definitions
Percentile income
Percent of others earning less than you.
Age
Years since date of birth.
Family structure
Relationship status, children or no children.
Education
Amount of schooling completed
Race
Categorizing by similar biological traits.
» The Percent of others earning less than you.
Year 1995
Year 1992
Year 1998
Mean
% of families Mean % of families Mean % of families
Income that saved
income that saved
income that saved
Percentile of income
Less than 20
20 - 39.9
40 - 59.9
60 - 79.9
80 - 80.9
90 - 100
9.9
24.1
41.2
65.6
97.4
228.1
30.2
50.0
58.4
70.2
71.0
82.0
9.4
24.9
42.7
65.6
98.6
248.9
31.4
43.3
57.1
67.1
70.2
83.8
10.5
26.9
45.3
72.4
106.1
291.6
32.1
44.9
56.1
68.6
73.4
82.0
Year 2007
Transaction acct. CD
Savings bonds Bonds
Stocks Pooled inv. Funds Retirement Cash value life insur.
Percentile income
Less than 20
20-39.9
40-59.9
60-79.9
80-89.9
90-100
74.9
90.1
96.3
99.3
100
100
9.4
12.7
15.5
19.3
19.9
27.7
3.6
8.4
15.2
20.9
26.2
26.1
5.5
7.8
14
23.2
30.5
47.5
1.4
1.8
8.9
3.4
4.6
7.1
14.6
18.9
35.5
10.8
35.8
55.6
74.3
86.9
89.6
12.8
16.4
21.6
29.4
30.6
38.9
Year 2010
Transaction acct. CD
Savings bonds Bonds
Stocks Pooled inv. Funds Retirement Cash value life insur.
Percentile income
Less than 20
20-39.9
40-59.9
60-79.9
80-89.9
90-100
76.2
91.1
96.4
98.9
99.8
99.9
5.7
11.1
11.7
15.8
12.1
21.5
3.6
6
10.8
16
23
24.4
0.1
1.3
2
8.3
3.8
6
11.7
17.3
25.7
47.8
2.1
3.5
5.8
8.8
14.6
32.1
11.2
30.5
52.8
69.7
85.7
90.1
10.7
17.2
19.5
22.8
25.8
30.9
» Years since date of birth.
Year 1998
Year 1992
Year 1995
Mean
% of families Mean
% of families Mean
% of families
income that saved
income that saved income that saved
Age
Less than 35
35–44
45–54
55–64
65–74
75 or more
46.0
70.7
86.0
75.3
44.0
35.4
59.1
56.9
58.9
59.3
54.1
49.4
44.2
69.1
93.8
76.5
53.1
37.5
56.4
54.3
58.0
58.0
50.0
51.7
48.2
80.0
92.8
95.3
62.0
38.7
53.0
57.3
57.8
60.9
56.3
48.6
Year 2007
Transaction acct. CD
Savings bonds Bonds
Stocks Pooled inv. Funds Retirement Cash value life insur.
Age
less than 35
35-44
45-54
55-64
65-74
75 and more
87.3 6.7
91.2
9
91.7 14.3
96.4 20.5
94.6 24.3
95.3 37
13.7
16.8
19
16.2
10.3
7.9
0.7
1.1
2.1
4.2
3.5
13.7
17
18.6
21.3
19.1
20.2
5.3
11.6
12.6
14.3
14.6
13.2
42.1
57.8
65.4
61.2
52.7
30
11.4
17.5
22.3
35.2
34.4
27.6
Year 2010
Transaction acct. CD
Savings bonds Bonds
Stocks Pooled inv. Funds Retirement Cash value life insur.
Age
less than 35
35-44
45-54
55-64
65-74
75 and more
89 5.7
90.6 5.7
92.5 10
94.3 14.6
95.8 20.6
96.4 27.2
10
11.6
15
14.3
9.1
10.1
0.4
1.4
2.4
3.4
3.6
10.1
12.1
16
19.5
16.1
20.1
3.6
7.7
9.6
11.3
11.1
11.9
41.1
52.2
60
59.8
49
32.8
9.6
12.3
19.8
25.7
28.4
32.4
» The relationship status and age of someone and
whether or not they have children.
Year 1998
Year 1992
Year 1995
Mean
% of families Mean % of families Mean % of families
income that saved
income that saved
income that saved
Family structure
Single with child(ren)
Single, no child, age less than 55
Single, no child, age 55 or more
Couple with child(ren)
Couple, no child
31.9
40.4
28.7
84.9
74.5
45.1
52.3
46.8
62.1
65.2
29.8
37.7
31.5
85.8
82.9
36.9
51.1
44.4
60.1
65.6
33.7
41.1
34.9
96.4
92.6
39.0
52.0
48.0
59.1
65.9
Year 2007
Transaction acct. CD
Savings bonds Bonds
Stocks Pooled inv. Funds Retirement Cash value life insur.
Family structure
single w/ child
single no child less than 55
single no child older than 55
couple w/ child
couple without child
81.1
9
87.4 9.9
94.6 24
94.3 12.5
95.7 22.5
10.9
9.4
9.6
24
11.6
2.1
1.2
2.9
7.1
18
13.5
18.9
24.1
6.8
8.9
10.8
12
14.4
35
46.7
36.7
62.1
62.6
21.4
10.2
22
23.6
30.2
Year 2010
Transaction acct. CD
Savings bonds Bonds Stocks Pooled inv. Funds Retirement Cash value life insur.
Family structure
single w/ child
single no child less than 55
single no child older than 55
couple w/ child
couple without child
84.9 6.7
88.3
6
92.8 20.1
94.3 10.4
95.9 15.8
6.3
6.3
8
18.9
12.4
2.5
1.2
2.9
6.9
10.7
11.9
17
20.9
3
5
9.5
9.1
12.4
34
40.2
33.7
60.1
61.6
11.1
9.8
23.5
18.9
27.9
» The amount of schooling completed
Year 1992
Year 1998
Year 1995
Mean
% of families Mean
% of families Mean
% of families
income that saved
Income that saved income that saved
Education
No high school diploma
High school diploma
Some college
College degree
26.4
45.6
56.2
99.4
38.1
56.8
59.5
68.1
29.6
49.6
57.5
101.2
42.8
50.6
54.1
68.2
29.0
49.4
67.7
113.8
39.5
53.7
56.6
65.6
Year 2007
Transaction acct. CD
Savings bonds Bonds Stocks Pooled inv. Funds Retirement Cash value life insur.
Education
No high school diploma
High school diploma
Some college
College degree
75.7 9.5
90.9 14.1
93.9 14.1
98.7 21.6
3.4
11.5
16.4
21.6
0.6
1.2
3.3
3.9
9.3
17.4
31.5
2.2
5.8
8.9
21.4
21.6
43.3
53
73.9
12.6
22.6
23.4
27.2
Year 2010
Transaction acct. CD
Savings bonds Bonds Stocks Pooled inv. Funds Retirement Cash value life insur.
Education
No high school diploma
High school diploma
Some college
College degree
77.4
6
90 10.8
94.6 11.8
98.4 15.8
2.7
9.1
11.7
11.7
0.2
1
3.6
2.2
8.1
11.3
27.2
3.2
5.4
17.6
17.1
40.6
48.6
70.5
11.9
19.8
17.3
23.3
» Categorizing based on biological traits or culture.
Year 1995
Year 1992
Year 1998
Mean
% of families Mean % of families Mean % of families
income that saved
income that saved
income that saved
Race or ethnicity
White non-Hispanic
Nonwhite or Hispanic
67.1
41.3
61.0
44.9
69.6
41.4
59.1
41.7
78.8
44.3
60.0
42.3
Year 2007
Transaction acct. CD Savings bonds Bonds Stocks Pooled inv. Funds Retirement Cash value life insur.
Race/ethnicity
White
non white or hispanic
95.5 19.4
83.9 8.2
17.8
7.8
2.1
9.4
21.4
9.4
13.7
5.8
58.5
39.5
25.3
17.6
Year 2010
Transaction acct. CD Savings bonds Bonds Stocks Pooled inv. Funds Retirement Cash value life insur.
Race/ethnicity
White
non white or hispanic
96.5 15
84.3 6.5
14.8
6.3
2.3
0.2
18.6
7.9
11.6
2.6
58.1
34.4
22.6
13.7
» Based off the data I have noticed some trends…
It appears that percentile income and risk tolerance are positively
related. The higher a persons percentile income the higher their
average income was, the higher the percentage of families who saved
was, and the more percent of assets they held.
As for age I did not feel there was strong enough evidence to make
any reliable conclusions.
When examining family structure it appears couples have higher risk
tolerance than those who are single, specifically couples without
children.
» It also seems that education and risk tolerance are positively
related to one another. The more education someone had the
larger their average income was, the higher the percent of families
who saved was, and the more percent of assets they held was.
» As for race it appears that whites have higher risk tolerance than
non whites. Whites had higher average incomes, higher
percentages of families that saved, and higher percentages of
assets held. However I feel that data could have been represented
in a better way that would give more reliable results. I did notice
also that between 1992 and 1995, Whites average income
increased by 3.6% while non whites income only increased by
0.2%. I also noticed that between 1992 and 1995, whites percent
of savings only fell by 3% while non whites fell by 7.1%.