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Risk: A Behavioural Perspective

By Lisa Brenneman and Laura Goodyear

Research from TD Wealth and Behavioural Economics in Action at Rotman (BEAR) shows the importance of understanding the risk tolerance of investors.

Piggie Bank floating on water

In the realm of investing, ‘risk profiling’ is a fundamental aspect of determining suitable investment solutions for an individual. Creating a risk profile entails determining and addressing two things: the individual’s objective risk capacity (their objective ability to take risk), as well as their risk tolerance (their behavioural willingness to take risk). Until recently, these varied traits have been difficult to capture effectively. 

In this article we will summarize the existing literature on how certain behaviours and psychological factors — in particular, the Big Five personality traits — impact investor’s behaviour around risk. We will then share the findings from our own recent research, published in its entirety in the TD Wealth Behavioural Finance Industry Report: A Behavioural Perspective on Risk. By bridging previous findings with our own, we hope to provide important insights for financial advisors and investors alike. 


Objective vs. Behavioural Factors of Risk

Not all investors with the same objective characteristics — age, gender, occupation — prefer the same level of risk in their investment portfolio. Effectively developing a customized, long-term investment strategy demands an understanding of a particular individual’s approach to risk.

Researchers have distinguished between the objective and behavioural components of risk. Our ‘risk capacity’ involves more objective measures, such as economic circumstance, investing time horizon, liquidity needs, debt, income and accumulated wealth. Risk capacity is relatively immune to psychological distortion or subjective perception.

Risk tolerance, however, can be defined as the combination of the psychological traits and emotional responses that determine one’s willingness to take on risk. For example, as loss-averse human beings, many people become anxious about potential losses during market downturns and may prefer to maintain a certain level of personal comfort over time. Essentially, as with most aspects of life, we are driven to do things that make us feel better. However, in the realm of investing, the decision to remain emotionally comfortable can come at the expense of significant long-term gains.

The research in this arena shows that some people are more or less likely to experience these emotions based on their personality. Research indicates that the Big Five personality traits — Extraversion, Conscientiousness, Openness, Reactiveness and Agreeableness — are related to risk preferences and subsequently, to investment decisions. Following is a summary of the findings, by trait.

Piggy bank with dollar sign

The decision to remain emotionally comfortable can
come at the expense of significant long-term gains.


EXTRAVERSION. High scores on Extraversion have been linked to a high risk-taking propensity — both in life generally and in the financial domain. Researchers posit that high levels of Extraversion supply the motivational force (i.e. sensation seeking) behind risk taking. In terms of investing, studies have found that people who score high on Extraversion tend to report greater intentionality to engage in short-term investments. Elsewhere, research conducted to determine the investing behaviours of self-directed investors found that extraverted individuals pay higher prices for financial assets — and buy more financial assets when those assets are overpriced.

CONSCIENTIOUSNESS. Researchers have associated this trait with risk aversion. In one study, low scores on Conscientiousness were linked to higher risk-taking propensity, both in life overall and in the financial domain. The authors of that study suggested that low levels of this trait reduce cognitive barriers to engaging in risky behaviour. 

REACTIVENESS. Lower scores on this trait have been linked to higher risk-taking propensity as low levels of Reactiveness provide insulation against concerns — like anxiety and guilt — related to the negative consequences of taking risks. In other words, those who have a more reactive personality have a lower risk-taking propensity in part due to concerns about the potential negative consequences of investing. In one study, those high on the Reactiveness trait were found to sell financial assets at lower prices, to purchase more when financial assets were underpriced and to hold less risky assets overall. Researchers suggest this is due in part to greater pessimism and fear amongst reactive individuals. 

AGREEABLENESS. Low scores on this trait have been linked to a higher propensity to take risks, both overall in life and in the financial domain. Researchers posit that low levels of Agreeableness provide insulation against the guilt or anxiety related to the negative consequences of risk taking. However, some studies have found no relationship between this trait and investment decisions. 

OPENNESS. In one study, individuals with high levels of this trait were found to have the greatest probability of taking greater risk in their investment decisions. Researchers posit that Openness provides the motivation to take risks, both overall and in the financial
domain. In another study, people who scored high on this trait were more likely to engage in long-term investing. 

In addition to personality traits, other characteristics also play a role in individuals’ willingness to take risk. For example, one study found that those who had a written financial plan were less likely to move investments away from equities during the financial crisis of 2008. And several researchers have found links between a person’s willingness to take financial risk and their level of financial literacy, and investing experience. One key takeaway is that those who are more financially literate are consistently more willing to accept financial risk. Interestingly, risk propensity differs markedly in its distribution across job types and business sectors: people working in Human Resources, Public Relations, Communications and Finance roles have lower reported risk taking and overall lower risk propensity than people working in other functions. Consultants were found to be the greatest risk takers.


Our Research

As indicated, the literature suggests that both behavioural and psychological factors play a role in determining an individual’s risk profile. We wanted to delve further into how psychological factors manifest themselves in investment behaviours. In September 2018, we conducted an online survey of 2,088 Canadians. Sixty-four per cent of participants were female and thirty-six per cent were male. Fifty-five per cent were over the age of 55; 21 per cent were aged 35 to 54; and nine per cent were aged between 18 and 34. We distinguished ‘wealth level’ as follows:

Mass Affluent: $100,000 to $750,000 in Investable Assets (80% of participants)

High Net Worth: >$750,000 in Investable Assets (15% of participants)

Emerging Affluent: 25 to 34 years of age + >$100,000 in household income (5% of participants)

Our analysis of the survey responses yielded three key findings.


We were surprised to find that less than half of affluent Canadians in our survey had a goal-based financial plan in place. However, those who did have a plan were twice as likely to stick to it during a market crisis versus those who did not have a plan in place.

IMPLICATIONS: This is consistent with previous findings where clients who had a written financial plan were less likely to move investments away from equities during the 2007-08 financial crisis. Our findings suggest that having a financial plan is something affluent Canadians would benefit from, but few have. This highlights that advisors can deliver more value to their clients beyond investment management. Preparation of a goal-based plan and helping clients manage emotions and achieve their retirement goals.


Survey respondents who claimed to be ‘a knowledgeable and confident investor’ were 3.5 times more likely to prefer a more volatile portfolio — that is, a portfolio that would likely lose money in multiple years but offered potentially high long-term growth. 

IMPLICATIONS: This is consistent with findings from previous research that knowledgeable investors tend to take more risks. Choosing a more volatile portfolio always involves a trade-off between risk and reward, and confident investors may believe they can take this on. However, some may not have the personality or capacity to manage the inherent potential for loss. Believing oneself to be knowledgeable and confident regarding investing does not necessarily make someone a good or profitable investor. In fact, these individuals may suffer from overconfidence — the tendency to hold a misleading assessment of their own skills, intellect or talent. This is consistent with previous findings that over-confidence can lead to a belief that one is more skilled than the average person and therefore better able to navigate or avoid negative situations. This can lead to errors in judgment with respect to the degree or need for risk mitigation strategies.


The participants in our study who self-identified as having a ‘volatile income’ or as working in a ‘volatile industry’ were 2.5 times more likely to select a volatile portfolio — that is, a portfolio that was likely to lose money in multiple years but offered the potential for higher long-term growth — than a portfolio that was unlikely to lose money in any one year, but was unlikely to show much long-term growth. These individuals were also four times less likely to say they were ‘very satisfied’ with their retirement-readiness than those who self-identified as having less-volatile careers. Interestingly, younger respondents (18 to 34) were nearly two times more likely than middle-aged respondents and nearly three times more likely than those 55 and over to have a self-described volatile income or to work in a volatile industry.

IMPLICATIONS: Viewing oneself as having a volatile income or as working in a volatile industry may be linked to riskier decision making with respect to investment decisions, which is consistent with findings from past research. This additional risk-taking behaviour coupled with a volatile income could explain why this group is less likely to feel that they will be retirement-ready. Many younger Canadians in our study had a minimum household income of >$100,000 or had >$100,000 in investable assets, yet still reported that they work in a volatile industry or have a volatile income. As younger Canadians enter the workforce, this potential sense of instability may be a result of the younger generation often working in contract positions in the ‘gig economy’. This could lead to different financial planning challenges than advisors have seen in the past.


The Big Five Traits

Respondents to our survey also completed a 50-item evaluative framework assessing the Big Five dimensions of personality discussed earlier. The results presented below are based on our correlational (not causational) analysis and represent a statistically significant relationship between a given personality trait and the behavioural variable of interest. 

EXTRAVERSION. In our study, those who were extraverted were more likely to assess themselves as being ‘a knowledgeable and confident investor’; more likely to think about their portfolio when the stock market was in the news; and more likely to stick to their investment strategy during a market downturn. Our results are consistent with the prior research that concluded this personality trait predicts greater risk taking. These findings could suggest that those high in the Extraversion trait are more likely to be self-directed investors who engage in their own portfolio management. Additionally, while those scoring high on this trait stated that they were knowledgeable and confident investors, prior research has found that Extraversion can also be linked to overconfidence. This suggest that highly extraverted investors might require additional guidance from advisors.

Image of safety ring float

When conscientious investors make investments, they
are able to stay the course during market turbulence.


CONSCIENTIOUSNESS. In our study, those who ranked high on this trait were less likely to say they had a volatile income or worked in a volatile industry. They were also more likely to assess themselves as being ‘a knowledgeable and confident investor’; more likely to think about their portfolio when the stock market was in the news; and more likely to be able to stick to their investment strategy during a market downturn. Given that prior research found that people who score high on Conscientiousness are also more likely to have a goal-based financial plan with an advisor, our results seem logical. Our findings suggest that when conscientious investors make investments, they are able to stay the course during market turbulence, which may be due in part to their financial knowledge and/or to their relationship with an advisor who coaches them during a market downturn to help manage their discomfort and ensure they stick to their plan.

REACTIVENESS. In our study, those who were shown to be reactive were more likely to self-report as having a volatile income and/or to work in a volatile industry; less likely to assess themselves as being ‘a knowledgeable and confident investor’; more likely to think about their portfolio when the stock market was in the news; and less likely to be able to stick to their investment plan during a market downturn. Our findings are consistent with previous research showing that reactive investors sold financial assets at lower prices and made more sales when financial assets were underpriced. Given that they feel less confident in their investment knowledge, reactive individuals may need additional advisor coaching and support, as they are more likely to become anxious or nervous during market turbulence. 

AGREEABLENESS. In our study, those who were found to be agreeable were less likely to say they worked in a volatile industry or had a volatile income. In general, people who are agreeable tend to value social harmony and ‘go with the flow’. While prior research suggests that agreeable individuals have a higher risk propensity, our research suggested no such relationship with risk-taking behaviours. These differences may be due in part to differences in the sample and the methodological features of the studies. 

OPENNESS. In our study, those scoring high on this trait were more likely to assess themselves as being ‘a knowledgeable and confident investor’; more likely to think about their portfolio when the stock market was in the news; and more likely to stick to their investment plan during a market downturn. Consistent with previous findings that people high on this trait are more likely to engage in long-term investing, we similarly found that these individuals are also more likely to stick with their investments during downturns. Openness may also provide valuable insight into the client-advisor relationship. For example, those who score lower on this trait may be more conventional and conservative and thereby may value more traditional investment strategies. 


Key Takeaways for Financial Advisors

Our findings bear some important overall implications for financial advisors.

THE VALUE OF EVALUATING CLIENT RISK. Going the extra mile to understand the psychological and behavioural elements of risk tolerance can be just as important as being aware of risk capacity. Overconfident, highly extraverted investors, for instance, could prove to be challenging, as they may state they are willing to embark on highly volatile investing but, in truth, have neither the capacity nor the tolerance to do so. Advisors may want to remind these clients that while these risky investments have a potential upside, they may also hold future downsides. Gaining a full understanding of clients’ risk tolerance using evaluative techniques or risk questionnaires can minimize the chance that any one client holds a portfolio that is outside of their risk tolerance.

The Big Five Personality Traits


High conscientiousness is characterized by short-term sacrifice in pursuit of long-term goals. Low conscientiousness is associated with short-term compromise. 

High agreeableness suggests a more trusting and cooperative personality. Low agreeableness suggests a more inquisitive and challenging personality.

High reactiveness suggests a tendency to respond to emotional stress. Low reactiveness is characterized by calmness and emotional stability.

High extraversion is characterized by an outgoing nature and the tendency to seek attention. Low extraversion is indicative of a more reflective personality.

High openness indicates a willingness to experiment in pursuit of ideals or higher ambitions. Low openness is indicative of a safer, more pragmatic personality.

ADVISORS OWE IT TO THEIR CLIENTS TO PROVIDE A GOAL-BASED PLAN. Shockingly, over half of Canadians in our study with greater than $100,000 of investable assets did not have a plan. Additionally, those who did have a plan with an advisor were 34 per cent more likely to be ‘very satisfied’ with their retirement-readiness. Given the sizeable potential benefits to clients, preparing a goal-based plan with objectives, time horizons and action steps for tracking should be a fundamental step in a strong advisory practice. Not only could it increase savings and retirement readiness, it may also mitigate risky decisions amidst market downturns. During the planning process an advisor can educate their client on the balance of risk and reward within the context of their own risk capacity and tolerance. Goal-based planning becomes the foundation for the future, creating the necessary focus on progress towards goals and not only portfolio performance.

INVEST IN YOUR CLIENTS’ EDUCATION. Financial advisors have a critical role to play in helping educate their clients and increasing their investment knowledge. They can help clients understand the trade-off required by reduced probability of meeting goals or having to cut back on current lifestyle to save more. In our study, people who scored higher on the Reactiveness trait also scored lower on their self-assessed investment knowledge and experience. All clients — not just those who are highly reactive — can benefit from increasing their investment knowledge. An advisor is uniquely positioned to provide factual education to help their clients navigate wealth management as well as short-term market events when the relationship between risk and reward is most salient.


In closing

No one ever raised their hand and said they wanted behavioural finance coaching. However, as indicated herein, many people could benefit from it. The best financial advisors coach their clients to avoid behaviours that can be detrimental to their long-term goals, such as wanting to sell when the market is down or paying too much for a stock when the market is up. 

At times like these, a finance professional may feel more like a financial therapist than a financial advisor. But helping clients feel emotionally comfortable with their portfolio is essential, as behavioural errors can become costly over time. By embracing the insights outlined herein, advisors can have constructive conversations with their clients, reminding them that their portfolio has been created specifically to account for their risk capacity and tolerance. As a result, more and more investors will be well equipped to weather the inevitable storm of market cycles over the long term.

Lisa Brenneman is Head of Behavioural Finance at TD Wealth.

Laura Goodyear is a Research Assistant at Behavioural Economics in Action at Rotman (BEAR) and a PhD Candidate at the Rotman School of Management. 

This article has been adapted from the TD Wealth Behavioural Finance Industry Report: A Behavioural Perspective on Risk. It contains full citations for the research referenced in this article.

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