Risk tolerance and myopic behavior - evidence from Finnish retail investors

PURPOSE OF THE STUDY The objective of this paper is to investigate whether investors actually follow the investment advice given by their bank. The bank here is a major Finnish retail bank which gives investment advice to its private clients based on the data it gathers in its investment profile tool, as required by MiFID. The study focuses on comparing the asset allocations suggested by the bank to the ones chosen by the investors. This paper adds new important evidence about the behavior of investors and the functioning of the banks’ risk profiling methods under the MiFID regulations. The study provides a new dimension of investment horizon into the research and also includes longitude in the data for the first time regarding this topic. DATA The focus of the study is on private retail customers who have completed the Investment profile in the last quarter of 2008. The data set covers the true compositions of the customers’ investment portfolios at two dates: Dec 31, 2008 and Oct 31, 2009. The total amount of investors in the sample is 910. In addition to the information about the investment profiles and asset allocations the data includes demographic statistics such as age, gender and wealth. The trading activity of the investors is also studied. RESULTS The main finding of this study is that investors seem to clearly ignore the length of the investment horizon in their allocation decisions. Investors overweight equities in short horizons and underweight them in long horizons. The finding supports previous research on the myopic behavior of investors. Previous research finds that investors make investment decisions on much shorter intervals than their investment horizon would suggest. I also find evidence of disposition effect and market timing attempts by the investors. The results indicate that investors actively increased the weight of equities in their portfolios during the period. Some of the investors appeared to have increased the share of risky assets considerably more than others. The main characteristics of those investors included risk-averse risk profile and high trading activity