Pakistan Academy of Marketing Journal

2016, Vol. 01, No. 1, 1417.

An Exploration Into Behavioral Aspects Of Asset Allocation

1 Mohsin Younis & 2 Abdul Rauf Kashif
Iqra University Islamabad Campus, Pakistan
Email: mohsin_younis@hotmail.com

Abstract
Personality type and cognitive abilities of an individual provide base for efficient and effective asset allocation, individual can foresee
logically better and consistent judgment to allocate financial resources. We investigate the effect of the personality type along with
cognitive abilities of an individual that encourage the individuals towards risk tolerance, which leads to asset allocation. We find that
cognitive abilities and personalities type affect the risk tolerance of individuals (shun or seek risk). Therefore, they remain consistent
and logical while allocating resources. Risk tolerance level of an individual determine the asset allocation whose with higher risk
tolerance have more stocks in their portfolios. This research provides significant understanding how personality type with cognitive
abilities of investor while designing their portfolios allocation in accordance with their risk tolerance.
Key Words: Risk Tolerance, Asset Allocation, Cognitive abilities & Personality

Introduction
Regardless of extensive research of almost 3 decades, the role played by different factors in the building up of human personality, the role played by
variables involved in the formulation of attitude of an individual and the extent up to which these factors influence the reasoning, judgment and decisions is
yet a controversial debate. As the human personality is not a predetermined automated mechanism neither their reflexes are certain, it is therefore difficult to
understand to the varying roles played by different factor in major decisions of humans. This uncertainty is multiplied when we are dealing with the behavior
of an investor, as the factors affecting the investors behavior also get multiplied.
Several factors playing role in the formation of individual investors behavior and perception have been identified by researchers. Starting from Grable
(1997), several constructs have been identified which play their role in individual risk perception, risk tolerance and investment decision making process.
Literature is evident that cognition may be associated with the proximate variables that play their role in financial decision making. Recent empirical studies
also find out that higher cognitive abilities are correlated with the willingness for taking risks and higher level of patience. Higher levels of analytical skills
are associated with higher level of risk seeking and patience Benjamin, Brown, and Shapiro, 2006). Dohmen, Falk, Huffman, and Sunde (2007) found out
in a sample of German adults that strong positive relation of cognitive abilities with patience and risk tolerance.
Another key factor identified by literature playing significant role in the determination of financial decision making and risk behavior of individuals is their
personality type. Marita et al. (2008) states that risk perception and behavior is like an interface between the personality type and individuals environment;
some individuals take more risk for accomplishing their objectives in comparison to those who adjust their activities accordingly. Cliff et al. (2008) found
that personality and education help creating atmosphere that influences or contributes the investors intentions for openness and risk avoidance to achieve
their future objectives.
Previous studies which estimate the correlation between personality types and risk behavior of individuals have not included the impact of cognitive learning
and abilities of individuals which may confound the interpretation of their results. At the same time, empirical studies have established a strong association
between the cognitive abilities and risk attitude of an individual, but not have tried to establish the overlapping impact of cognitive abilities and personality
type of individuals which may sometimes lead to a different risk behavior. The projection of the risk tolerance on the ultimate economic decision of
investment is also lacking.
This research aims at the establishment of the overlapping effects of cognitive abilities and personality type of individuals, and further studies the mediating
impacts of the risk behavior of individuals on the asset allocation decision. This paper is also complementary to other contributions linking cognitive abilities
and personality traits with risk tolerance levels of the individuals and further projecting their impact on the asset allocation decisions. It also provides a more
comprehensive analysis of the relationship between the risk tolerance levels of individuals and asset allocation decisions thereupon.

Literature Review
Asset allocation requires certain human capital investment, both in terms of time and efforts which are mandatory for familiarizing oneself with the concepts
of transaction costs, volatility, returns on assets, and the covariance between the returns on assets. The concept of risk propensity has important implications
for the theoretical modeling of risk behavior and for practical insights into the motives underlying individual level choices about engaging in risky behavior
(Nigel et al. 2010). Certain aspects of the individual traits impact this process of familiarization and play their own roles in the determination of the financial
decision making of the individuals and further asset allocation. So, it becomes crucial to study the roles played by those factors and is of significant
importance.
Previous research has found the significant impact of personality types on the individual risk perception and financial decision making. Personality is
characterized as those characteristics that affect behavior and motivation of an individual and also affect his decision making. There are many aspects of
personality that is measured by many scales. Myers-Briggs Type Indicator (MBTI) is a modern scale and tool which measures the personality on Four broad
dimensions.
The Myers-Briggs Type Indicator is extensively documented as personality preference measurement instrument. It has been extensively used in education,
business and counseling (Myers, 1980; McCaulley, 1976; Bates, 1978; Lawrence, 1984). It is based on work by Carl Jung, who documented that
psychosomatic preferences play a role in how one see the outer world. It determine the weaknesses or strength of preferences of a person in four areas 1)
where one focus his attention (introversion versus extraversion),2) how one get information about his environment (intuition versus sensing),3) how one
make decisions (feeling versus thinking), and 4) how one become conversant with surroundings (perception versus judging).
The four scales of the MBTI appear in

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Pakistan Academy of Marketing Journal

Focusing attention: Extroverted individual focuses on the external things and world, they draw energy and learn effectively when being engaged and
interacting. Introverted peoples focus on their inner self. They draw energy from their inner world. They try to understand the background of a problem
before solving it.
Acquiring information: Peoples who prefers sensing for acquiring information, gives value to physical side of situation, they are practical minded, anxious
about the facts details and accept what is given. The introverted individual focus on intangible and value relationship that is intangible. They try to
understand the overall situation rather than details and concentrates on future possibilities and change.
Making decisions: Individuals who prefer thinking focuses on making fair decisions. They want a logical analysis of situations and desire to achieve the
objectivity. They try to find out the mistakes, which they may make in analysis of a situation.
It has been observed that individuals who draw energy from external things from engaging and interacting are more likely to take financial risk. The
individuals who prefer sensing for acquiring information and anxious about the facts and figures, they accept whatever is given to them; therefore they are
more likely to avoid risk. The individuals who prefer thinking for decision making are likely to take more risk. Similarly the individuals who prefer judging
in their orientations towards world lead a well-disciplined life and those who prefer the perceiving are more flexible. They accept change and adjust
themselves with it. So, the individuals who prefer the perception in decision making will take more risk. So we can say that individuals who are extrovert
and who prefer the intuition, thinking and perceiving dimension will take more financial risk (Fileback, Hatfiel & Horwath, 2005).
Cognitive abilities or cognition may be defined as the act or knowledge of knowing or perceiving. It is a mental processes, including understanding,
reasoning, knowledge, and intellectual capacity. Dohmen, Falk & Huffman (2007) found significant relationship between cognitive ability, patience and risk
aversion. Individuals with higher levels of cognition are characterized as more risk tolerant and patience than the individuals who score low in cognition.
Cognitive abilities of individuals strike while making choice for buying financial assets; individuals with poor cognitive abilities find difficulty in collecting
and processing information leading to a processing cost (Christelis et, al. 2007). According to Dickens (2007), there are many dimensions of cognitive
abilities which all are almost interrelated
and are vital in predicting and evaluating the economic outcomes and explaining the successes or failures. George and Kumar (2004) found out that the
performance of the portfolios increase with increase in experience but at the same time it is negatively related with age as distortion of cognitive abilities
also plays its role.
The work on the relationship between the individual traits and his risk perception, propensities, tolerance, economic decision making has been exhaustive,
but still no study has yet been concluded that first identifies the interrelationships of the personality type and their cognitive abilities; and secondly interprets
the mediating role of the risk behavior or tolerance on the asset allocation decision.

Theoretical Frame Work

In this paper, we combine the several variables influencing the risk tolerance of investors and check the mediating impact of the risk tolerance on the asset
allocation decision of the investors. Thus the model is as follows:

Cognitive Abilities

Risk Behavior

Asset Allocation
Decision

Personality Type

Discussion & Conclusion

As Marita Klosevk, Richard G Crilly, and Maggie Gibson (2008) argued that generally personality is perceived as understood catalyst for determination of
the behavioral choices by individuals; within this multifaceted depiction of challenge and want. The views regarding the personality and personality types
have changed overtime.
Traditionally, personality was considered as a stable phenomenon which remained constant throughout life. However, it is being recognized that change
occurs in different people up to different degrees in different personality domains. Researchers have also consensus that different life events and incidents
cause this change. Change can also be purposefully brought by the individual, who is not satisfied by any certain aspect of his personality. This change can
be brought through specific training, efforts or counseling.
Investors generally rely on the persuasiveness and cognitive learnings they get through their environment. Investors, after getting information, are faced
with the question of rejecting or accepting that communication or its persuasion. Then the investor relates that information with his existing body of
knowledge, his attitude, past experiences and his feelings, etc. During this course of relating, the investor rehearses the cognitive content above that of the
persuasive information itself. So, the learning through the cognitions and cognition content are more persuasive than the communication content.

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Mohsin Younis & Abdul Rauf Kashif

The personality of any individual plays its due role in determination of the risk behavior of the investor and further in the asset allocation decision of the
investor, but the cognitive abilities of the individual foster the impact of the cognitive content of the information supplied to the investor through its
environment. Hence cognitive learning has significant impact upon the investors risk behavior and asset allocation decision, and can multiply the risk
behavior, averse or seeker, of the individual.
So, by personality a person is risk averse, but is good at cognitive learning, then there are ample chances that he may through his cognitive learning take
risky decisions as he is good a learning through his experiences and implements his knowledge on information supplied to him. At the same time, if any
investor who is risk seeker by his personality, but weak at the cognitive learning, is confronted with chances of giving up any risky decision gathering
information, processing it, learning about available financial products, and then in getting himself familiarized with their different characteristics. So, we
may conclude that cognitive learnings of individual help individual investors making rational decisions towards risk seeking and asset allocation decision,
and that the cognitive abilities also control the personality based internal inclination of investors towards any particular portfolio.

Practical Implications
The implications of this paper are threefold. First for the investment consultants, as the frame work is helpful in prediction of the investors risk tolerance.
Second, it provides an insight into the factors along with the risk tolerance of the investors may vary, so by focusing those variables they can significantly
stimulate the investors risk tolerance. Third, it opens an avenue to the discussion regarding the overlapping impacts of the variables in determination of the
behavioral aspects of the investors.
This research has significance for the financial advisors / consultants and the findings of this research will help them in undermining the risk tolerance of
investors while designing portfolios for them and asset allocation decisions will be taken thereupon. This will also help Fund managers in allocating
resources of their clients, companies, and investment according to their risk tolerance to address this "human side" of risk tolerance.

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