How Do Individual Investors Take Risk? - A Study on Risk in Contribution-Defined Pension Plans

Abstract: Studying individual investors' behavior is challenging because the context in which individuals invest is difficult to model and actual behavior is difficult to measure. Individual investors present several features which give their investment situation a special character: They have long but finite planning horizons, important non-traded assets such as the human capital and important illiquid assets such as housing. This study investigates the effect of socioeconomic variables on individual investor risk behavior using data on Swedish unit linked insurance plans within contribution-defined occupational pensions. To infer risk, we measure total risk, systematic risk and the proportion of idiosyncratic risk in the investment portfolio. We find strong evidence of a parabolically shaped relationship between risk and age where total risk increases up to the age of 43 from where it decreases at a growing rate until retirement. We also find that investors with a high willingness to take financial risk take higher total and systematic risk as well as a greater proportion of idiosyncratic risk. This could be the result of a well informed individual investor or a well working advisory system.