“What is Your Risk Tolerance?” asked a few questions to help determine your risk comfort level.
I want to flesh those questions out using a classic investor personality model, the Bailard, Biehl, & Kaiser Five-Way Model.
I am not a “fit in a box” guy. It is rare to find someone who is an exact match within any personality model. But understanding how your general tendencies impact your decision making is useful. Learning more about who you are as an investor will ease your shift to become a more unemotional, objective, and successful investor.
Investor Psychographic Models
Investor psychographic models can help investors determine their own risk tolerance.
Pyschographics refers to the description of an individual’s psychological characteristics. It attempts to classify investors based on their personality traits.
There are a variety of models in use today. I suggest you review a couple of models to better understand your own investor profile. In this post, we shall look at the Bailard, Biehl, & Kaiser Five-Way Model.
The key to this model is that it focuses on two personality traits: investor confidence level and preferred method of action.
Investor confidence may range from being totally confident to being wholly anxious in investing abilities.
An investor’s method of action considers how methodical, analytical, and intuitive an investor is in his actions. One’s method of action may range from extreme carefulness or caution to being highly impetuous or reckless.
Confidence and method of action are plotted on two axes and investors are grouped according to their preferences. In this model, there are five possible investor profiles.
Guardians
Guardians are extremely cautious and anxious in their behaviour. Preservation of capital is paramount. Guardians are very risk averse and do not want to incur any monetary losses.
Often, older investors fall into this category. Older investors need to preserve their assets and usually want secure investments with a steady, stable income flow.
That said, new investors may also fall into this category. As knowledge and experience levels are very low, new investors may want to take a cautious and safe investment approach until they gain sufficient skill to move into riskier assets.
Guardians typically invest in government backed bonds or treasury bills, term deposits, preferred shares in public companies, and balanced mutual funds. Low risk of capital loss, but with little hope of significant capital gains.
Celebrities
Celebrities are investors who are anxious but, at the same time, are also impetuous. Not a combination that usually results in long term success.
Celebrities exhibit a crowd mentality and like to invest in the latest hot investments.
For example, if gold is in vogue amongst the media talking heads, Celebrities will invest in gold. Or if a friend at a cocktail party mentions some new biotech company, the Celebrity will want to purchase shares as well.
Whether the investment in question is potentially positive from an analytical perspective or whether it is appropriate for the specific investor are usually not considerations for the Celebrity.
Celebrity investors may be of any age group although I suspect more fall into the young or middle age groupings. This is because over time, Celebrities will not usually be financially successful following this path and move on to more structured investment approaches (or they will have lost all their capital).
Celebrities invest in a wide variety of assets, usually creating a haphazard portfolio. One that tends to be of higher volatility. The only common theme is that the investment is currently fashionable. That often excludes investments in plain-vanilla (i.e. boring) assets such as term deposits, treasury bills, and balanced mutual funds.
Can you just picture a Celebrity discussing his 90 day term deposit at the local bank when all his friends are raving about their shares of Albanian hi-tech companies? Neither can I.
Celebrities are prime candidates for getting caught in an investment bubble.
Adventurers
Adventurers are highly confident, but impetuous.
Adventurers are strong-willed individuals who may be entrepreneurs in their work life. Often successful in business, they expect that success will flow into other areas of their lives. The difficulty is that these individuals do not typically have the time nor the inclination to develop the necessary tools to also become successful investors.
As a result, Adventurers may act rashly and err in their investing decisions.
Adventurers are willing to take chances on their investments and readily consider higher risk assets that offer better potential returns. This would include smaller public or unlisted companies, real estate, venture capital, and derivatives.
Diversified portfolios are considered boring. Adventurers are comfortable investing a significant portion of their assets in one single investment.
Individualists
Individualists are strong willed and highly confident, but they act with care.
Individualists are very rational and analytical in their investing strategies. They understand the relationship between risk and return and take emotions out of their investing style.
Individualists are normally “do-it-yourself” investors, performing their own research and making their own decisions.
As they act with caution and not recklessness, Individualists make less fundamental investment errors than Adventurers.
Individualists invest in a wide variety of assets and develop diversified portfolios. They also tend to be contrarian in their approach and typically have an eye for value. Because of this, individualists may be able to avoid investment bubbles.
Professional investors normally fall into this investor category.
Straight-Arrows
By their vary nature, models tend to classify investors into extremes. In actuality, most investors fall somewhere in between the outer reaches.
Into this comes the Straight-Arrow classification. Where the “average” investor, who possesses some investment experience and knowledge, tends to sit.
Straight-Arrows do not clearly fall into any one category. There is overlap between the different classifications.
Straight-Arrows have some confidence. Not the total level of an Adventurer or Individualist, but substantially more than exhibited by the Guardian or Celebrity.
Straight-Arrows act in a reasonable manner, for the most part. They normally act in a prudent and careful manner, but are still prone to recklessness and following the herd at times.
A Straight-Arrow should be open to investing in a wide variety of asset classes.
And You?
Where do you fit into this Five-Way Model?
Ideally, as an investor, becoming an Individualist is the best case scenario.
For most people who are not professional investors, finding the time and energy to become an Individualist is not usually possible. For these people, becoming a Straight-Arrow should be the goal to best achieve one’s investment objectives.
Straight-Arrows can prosper relying on a structured investment strategy incorporating a passive asset management style.
Straight-Arrows also benefit when working with a professional financial advisor. Straight-Arrows have an understanding of investing and can work in partnership with a professional to develop and implement a prudent investment plan.
If you are currently more of a Guardian, Celebrity, or Adventurer, no worries at this time. By understanding the weaknesses of each category, you can take conscious measures to eliminate the deficiencies in your investor profile and move toward a more well-rounded approach.
I understand that changing basic personality traits may not be easy. Some people are naturally anxious while others are confident. Some are cautious, others are rash. It is all part of one’s inner make-up.
Over time, I hope you will see that a rational approach to investing is the best way to invest. If you do, that will provide you with greater confidence and the ability to take on a more measured course of action in your investing activities.
