What impacts investment decisions?

Marriage, children and housing cause significant changes in risk aversion which affects people's choice of optimal portfolio mix


By CHOO XIAO LI, NG HUI YIN,WONG SOON LEONG and KONG YOON KEE

SOME key events in life bring about a significant change in attitude and perspective when it comes to making investment decisions. Marriage, for instance, brings with it a sense of joint ownership and responsibility for the couple as they set up a new family unit. Similarly, the arrival of the first child and subsequent ones brings additional long-term financial commitments and significantly affects their priorities in life.

Housing loan, probably the biggest financial commitment in life, requires setting aside a major part of the monthly salary and/or CPF contribution to service the monthly instalments. Many of us heave a huge sigh of relief when the loan is fully paid up.

Our team of three final-year students at Nanyang Business School, NTU, under the supervision of our lecturer, decided to study four key events: marriage, arrival of the first child/children, full repayment of housing loan, and use of CPF for investments for their impact on Singaporeans' attitude to savings, riskiness of their investment portfolios and conservativeness with respect to investments. We also looked at how age impacts individuals' risk aversion.

Overall, our survey findings show that major life events cause significant changes in risk aversion which affects people's choice of the optimal portfolio mix.

For instance, marriage results in a significant change in investment strategy as on getting married, people prefer to have less risky assets in their portfolio. We found that a mere 2.18 per cent indicated that they would choose the riskiest portfolio (comprising 60 per cent high-risk, 30 per cent medium-risk and 10 per cent low-risk assets) after marriage. This was a plunge from the one quarter of respondents (25.84 per cent) saying that before marriage they would choose the riskiest portfolio.

On the other hand, the proportion of those who chose the safest portfolio (10 per cent high-risk, 30 per cent medium-risk and 60 per cent low-risk assets) quadrupled from 11.80 per cent before marriage to a healthy 47.63 per cent after marriage.

Financial planners, wealth managers and others in investment advisory roles are encouraged to take special notice of the four events that we studied as these have been found to have significant impact on people's investment preferences and risk aversion.

We polled 500 adult Singaporeans through face-to-face and online surveys in December 2009 and January 2010. A total of 178 responded - equally split between men and women - giving a healthy response rate of 36 per cent.

Our survey showed that marriage leads to Singaporeans wanting to save more for their future, possibly for the downpayment for the HDB flat or private apartment and/or to prepare for the arrival of children.

Newly married couples are prepared to give up the potentially higher returns of riskier investments for the relatively stable returns of safer assets even though these typically provide lower expected returns. Marriage also leads many to lean towards making more conservative decisions such as selling their risky investments and opting for safer investments such as fixed deposits during a volatile market.

We believe that when a married individual is investing the combined wealth of the couple, he believes that his accountability is not just to himself but also to the spouse. Hence, he would take a more conservative approach in investing, which accounts for his shying away from riskier investments.

Our survey shows that the arrival of the first child also significantly impacts the attitude of Singaporeans to savings as they tend to save more in terms of number of months of savings available for living expenses. We found a huge increase in respondents who opt for more than 12 months of savings: from 24.16 per cent before marriage having their first child to a high of 71.35 per cent after marriage having their first child.

In addition, they prefer to invest more in safer assets and to make more conservative investment decisions after having a child or children. Bringing up a child or children can be costly for a typical Singaporean family. With education costs, child development expenses (tuition, piano, ballet lessons, etc) and medical costs that come with having children, parents make conservative investments to avoid any abrupt and substantial losses from investments that would make it difficult for them to fulfil their obligations.

Buying a house is probably the single biggest investment for many of us and it is a lifetime goal for many to own a fully paid home as quickly as possible. We find that Singaporeans want to manage their investments more conservatively while they are still servicing their housing loan: We observe that 28.65 per cent of the respondents see themselves switching to more aggressive investment allocations after fully paying off their housing loan. (Createwealth8888: I became more aggressive in stocks after fully paying off my house loan and emotionally stronger to ride bear market and economic downturn that may threathen job security)

In the event of unexpected adverse macroeconomic situation, a homeowner who is still servicing his housing loan may find that he is in negative equity with respect to his home, that is the amount that he owes the bank is more than the value of his apartment as its value had dropped significantly due to the bad economy. In this case, the bank may call upon the homeowner to repay some of the loan to reduce its exposure to him. The homeowner would be better prepared for this if he adopts a more conservative investment portfolio and has set aside more savings; otherwise, he risks foreclosure of his property by the bank.

At the same time, our results also show that Singaporeans tend to behave differently after they have paid off their housing loan in full as they will invest more aggressively and are more willing to accept higher risk in order to seek potentially higher return.

Besides cash, CPF is an important alternative source of funds for investments. Our survey shows that Singaporeans are more inclined to invest a greater part of their portfolio in riskier assets when they are using CPF monies compared to when they're using cash: A third (33.15 per cent) of the respondents will choose to invest in a more aggressive portfolio mix if they use CPF to invest, compared to just 7.3 per cent who will invest in an aggressive portfolio if they use cash.

A possible explanation is that Singaporeans do not view their CPF savings as 'cash'. While cash is immediately available to buy goods and services, CPF savings can only be used for selected purposes such as insurance, mortgage payments and retirement spending. Thus, they 'do not feel the pinch' when losses occur if they are investing using CPF.

Next, our survey also finds that people in different age groups differ in their risk aversion. Those between 21 and 30 exhibit the least risk aversion as they have minimal financial commitments to meet. Also, being younger, they have a longer time frame to recoup any financial losses.

On the other hand, those in their 30s are most risk averse. This could possibly be due to the fact that most of them face substantial financial commitments, given the need to support their children and repayment of housing loan. Those in their 40s are less risk averse than those in their 30s as they would most probably have lower outstanding housing loan liability and may have built up some savings by then.

Choo Xiao Li and Ng Hui Yin are final-year banking and finance students and Wong Soon Leong is a final-year actuarial science student at Nanyang Business School, NTU. Kong Yoon Kee is a lecturer of the school