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Taking risks in life can be scary, but it can be especially intimidating right now. The COVID-19 pandemic has caused many to struggle not only physically and emotionally, but also financially. In fact, according to a Pew Research Center poll, roughly four in 10 adults say they or someone in their household has lost their job because of COVID-19.
Like many Americans, Abed Golam Rabbani, an assistant professor in the Department of Personal Financial Planning of the University of Missouri College of Human Environmental Sciences, was tempted to adjust his financial portfolio and divest many of his stocks when the pandemic hit. He was compelled to decrease the amount of risk he was taking on. Ultimately, he resisted these urges, but he wanted to see how the pandemic was affecting others’ ability to keep taking on the financial risk that comes along with being invested in common high-risk stocks.
In a recent collaborative study with University of Georgia and South Dakota State University, he and his colleagues found evidence that people are moving away from taking financial risks during the pandemic. The study analyzed data acquired through the Investment Risk Tolerance Assessment — an MU online financial planning survey with over 231,000 responses — to discover how the pandemic affected people’s risk tolerance or their ability to take on financial risk, like purchasing certain stocks. Rabbani said that when someone’s risk tolerance is decreased, it has a very practical effect on the economy.
“It translates into their investment,” Rabbani said. “They’re telling their financial planner, I can’t take much risk right now, and they end up selling their high-risk stocks and investing in lower-risk stocks. Because their risk tolerance has lowered, it’s possible their portfolios could lose value over time because low-risk stocks often result in low returns and high-risk stocks tend to have high returns. As a result, you may not meet your retirement goals.”
Rabbani also broke the participants into groups of high-risk tolerance and low-risk tolerance to determine what types of people were most often in each group. Low-risk tolerant people were most often people with low household income, and people with low financial education, while high-risk tolerant people were most often people with high household income, and people with high financial education.
Rabbani found that even through the pandemic, the makeup of these groups hasn’t changed much. However, the percentage of people in the high-risk group decreased from 51% of people surveyed to 45% of people after the pandemic began. Inversely, the percentage of people in the low-risk group increased from 49% to 55% after the beginning of the pandemic, meaning people’s risk tolerance declined overall.
One group, however, has been particularly affected by the pandemic. Though young people are generally more risk tolerant, the risk tolerance of people aged 25 or younger decreased at a much greater level than everyone else. Rabbani said this could be an issue for young people.
“Risk-taking activities — driven in part by a willingness to take on a financial risk — leads to greater wealth accumulation,” Rabbani said. “If young people, in general, have reduced their willingness to take financial risk, the wealth accumulation possibilities for them may be in jeopardy. So, young people who are moving away from investing in risky assets are more likely to miss out on higher investment return.”
Instead of adjusting their portfolios based on current events, Rabbani argued that it is best for people to determine their reasoning for investing in the first place. He also said that there are drawbacks to people shifting their investments often.
“When you invest in the stock market, you should invest with a long-term goal in mind,” Rabbani said. “If you change your allocation, there will be service charges, investment charges, and others, and overall, it will have a negative impact on your assets. I think many people have made hasty decisions.”
For people thinking about making a decision based upon the fallout from the pandemic, Rabbani suggests taking a step back and thinking about what the money is for and when it is needed.
“A test of the association between the initial surge in COVID-19 cases and subsequent changes in financial risk” tolerance was published in Review of Behavioral Finance, and a similar study, “An Evaluation of the Effect of the COVID-19 Pandemic on the Risk: Tolerance of Financial Decision Makers”, was published in Finance Research Letters.
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