3.1.3 Do we really understand our appetite for risk?

What are the risks related to saving and investing, and how do consumers understand them, or what do they understand?

I think the first thing that struck me, very forcibly, from the research is that risk has different meanings, as Sue alluded to in her introduction, to different people. In the financial advice and investment industry, it’s really about the mathematical calculation of probabilities. For the rest of the world, for the general public, it generally means uncertainty. So as John Lanchester said in his recent book, it’s ‘the more profound unknowabilities of life and history’. I think the financial sector brings together those two, very different, understandings in an effort to help people make investment decisions.

In terms of what people understand, I think what the research showed, quite clearly, is that there are two different components in terms of people’s understanding of risk. There is a general understanding about the risk of saving and investing. What I’ve come to think about as environmental factors - things like interest or inflation. Then there is actually how do people think about their own attitude to risk.

Let’s turn first to general understanding. What we found in the research was from the literature and from other research that has been carried out, we know that the population has a very limited understanding of risk. It’s kind of limited in terms of investing; to knowing that they go up and down. In our population of consumers that we interviewed, it was a bit more sophisticated than that. It was that investments go up and down, but we do understand that our capital is at risk. What also came through really strikingly was, we know that if we don’t invest, actually there is a risk as well because of our savings being eroded by inflation. The bottom bubble is really things that stakeholders and the financial advice industry felt that people should know but probably didn’t, or, they probably didn’t know enough about these things, so, basic concepts, inflation, interest rates, how the markets work, the impact of charges on your investment returns? What actually does a good return look like? And what might your investment journey look like? The industry and the stakeholders that we spoke to thought that people didn’t have a good enough handle on that third set of things.

What about people’s attitude to risk? Let me remind us that the consumers we spoke to had some experience. They had either bought or considered an investment in the recent past. New investors are going to have much less of an idea than the people we spoke to. We broke it down into the four kind of components of attitude to risk as we understand it. Firstly, in terms of people’s willingness to take risk. Respondents the consumers that we spoke to generally had some sense of the risk they were prepared to take. They used this as a benchmark. People said, ‘I’m kind of middle risk,’ or, ‘I’m medium risk’, ‘I’m cautious’, so they had some understanding because they had been through a process. The sort of thing that influenced their attitude wont’ come as any surprise. It was life stage; having a young family, you take less risks. It was also their past experience. In terms of risk need, I think the striking thing, for me, from the consumer research was that people who were kind of made an active choice or were more active in their investment choices had a sharper sense of their risk need then people whose investment decisions had kind of fallen in their laps because of circumstances, so because of a bereavement or because of a redundancy, for example.

Risk capacity, for me, is one of the most interesting part of this because I think across the interview data, the stakeholders, the industry data, the consumer data, what we actually see is three dimensions to capacity to risk. The first is very present focussed. It’s consumers thinking have I got enough money to actually be able to afford to invest any money at all. The second thing came through much more strongly, from stakeholders in the industry, which is, consumers working out whether or not they have the building blocks in place in order to be able to afford to take some risk with the money they have got. That’s saying, ‘have I got enough savings to cover an emergency’? or, ‘do I have protection for myself and my family’? Once you have answered that second question, then it’s a question of saying, ‘what is my capacity for loss’? ‘What is the amount of money that I could afford to lose, if things don’t work out how I want them to’?

I think it’s true to say that the regulator would prefer investors to understand capacity for loss in a kind of quantitative way, in a pounds and pence way. Certainly, from the interviews that we did, capacity for loss was something people had in their minds although they might not express it, like that, but it was a qualitative sense. It wasn’t a quantifiable thing they thought about. They didn’t, really, think about it in pounds and pence.

Experience and expertise is the final aspect of attitude to risk and the interviews highlighted just the different ways people could gain experience and expertise which we might not always think about. Things like belonging to share clubs, peer influences, and actually things like being involved in running a business. I think the other thing the research shows us is that as well as attitude to risk, there is a question that’s worth asking, and investors worth asking of themselves which is, what kind of investor am I? From the research, I think, we see a continuum and this, I don’t think, will come as a surprise. From one end we’ve got people that are delegators so they delegate the research, they delegate the selection of the investment, they delegate the choice, the final choice of what they take out and usually, they’re going to delegate it to a professional advisor.

Moving along the continuum, we have affirmation seekers as we’ve called them. These are people who might do some of their own research they’re generally more engaged and pro-active but even so, they will seek affirmation or they will seek validation at the point of making the decision. They want to know, from someone else, that they’re doing the right thing; they want some reassurance. They might do some research but they might also seek some validation. That might be in the form of regulated advice, or, it might be on a non-advice basis, or it might be from a friend or relative, that they trust, who has some financial experience.

Then, we have the DIY investors. These are people who are more motivated to invest I think, because they are interested, or because they enjoy it. They are intrinsically motivated, as we would say, and it’s a very, intrinsic motivation is a very powerful determinant of action, so they do tend to do their own research; they will be making their own decisions and they feel confident that they’re making the right decisions, for them.