Helping consumers understand investment risk: experimental research into the benefits of standardising risk disclosure

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When consumers decide to invest their savings they must weigh up two main factors: the return that they want and the risk they are willing to incur. Finance theory teaches us that these are interrelated, as higher returns are typically associated with greater risk. The trade off between the two will also depend on the time horizon of the investment. When people are investing for the long term, for example when taking out a pension, opting for a product where the money is protected, but therefore offers low returns, may potentially represent a greater risk to people’s retirement aspirations. However, people find it difficult to assess risk, in part because their understanding of risk tends to be relative, rather than absolute: the choice of how much risk people are happy to accept depends on the context and how the risk is presented. A stark example of this is the work of Tversky and Kahneman (1981), which shows that it is possible to reverse people’s risk preferences depending on whether two identical choices are presented in terms of the number of people who will survive or the number who will die. It is against this background that consumers need to decide how much risk to take when investing their savings. One thing is clear – in order to make good investment choices, people need to be able to assess effectively the relative risks of the different options available. This research investigates whether there is a way of presenting the risks associated with different investment funds that will help people make this assessment. In particular we investigate whether using a pictorial presentation of risk, in the form of a synthetic risk reward indicator, helps people make better investment choices. We do this using an experimental approach, which allows us to assess the impact of different designs after controlling for differences in the sample of people seeing the different designs.