Older, but not Bolder

19. June 2012 by Christin Stock


If five winners share a lottery payout of two million, how much does each get? Although I arrived at the right answer – 400,000 – quite easily, this might not be the case in 30 or 40 years’ time. In one study, while more than half of subjects aged 53 were able to answer the question correctly, among the 90 year olds only 10 percent could[1]. That physical and mental capacity declines with age is no secret. As it becomes increasingly burdensome to do mental arithmetic, judge probabilities, etc., so it becomes more difficult to understand the risks and consequences of one’s decisions. For this reason, seniors tend to reduce their exposure to risks and avoid making decisions.

Ageing or, more appropriately put, the decline in cognitive ability, is one of the factors that contribute to people’s readiness to take or to bear risks. However, this is one of the few factors likely to influence predictably individual risk tolerances.  Apart from this there is unlikely to be any huge variation over time; our readiness to accept risk is to a large extent (perhaps as a much as two-thirds) genetically determined and is therefore likely to be relatively stable over our lifetime[2]. The financial markets will thus exprience a steady outflow of some participants as older investors retreat from riskier engagements or retire from some asset classes altogether. However, younger investors, more cognitively-able and risk-hungrier will also replace them. The numbers and the risk tolerances of the new arrivals might be different from those of the departed, but clearly the risk preference of the aggregate market will change only very, very gradually.

Watching the financial media one has the impression that financial market risk attitudes change on an hourly basis. It  constantly reports on to the ‘risk-on’/ ‘risk-off’ behavior of the market, or the rising or falling risk appetite, but the reality is that they are not referring to the risk preference at all, but rather to the risk perception. This variable is constantly changing because market participants are frequently forced to recognise that they have misjudged certain risks and have to modify their investment strategies. If at the start of year, for example, someone could not imagine that Spain would formally apply for an EU bailout for its creaking banking sector, they were enlightened at the latest last week.

When risky decisions have to made, be it financial investment or a parachute jump, a person’s readiness to take risks is always a product of the individual’s underlying risk preference and of his/her perception of those risks.

[1] Kasten, G.W. & Kasten, M.W. (2011): The Impact of Aging on Retirement Income Decision Making, Journal of Financial Planning, Vol. 24 (6), S. 60-62, 64-69

[2] Zyphur, M.J., Narayanan, J., Arvey, R.D. & Alexander, G.J. (2009): The Genetics of Economic Risk Preferences, Journal of Behavioral Decision Making, Vol. 22 (4), S. 367-377

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