Investors grow less apt to risk

The stock market just wrapped up one its best Septembers ever. But if investors threw any parties, they didn't invite me. Nor did I see any balloons or confetti floating around.

My suspicion is that Americans are still a little too shell-shocked for much celebrating. The economy is sluggish, anxiety over jobs remains high and many people are focusing more on other financial priorities such as cutting debt and building up emergency savings.

But recent studies suggest that Americans are becoming less risk-tolerant in general and perhaps even less rational in terms of assessing trade-offs.

For instance, the overall willingness of mutual-fund investors to accept risk still hasn't rebounded from the financial crisis, reports the Investment Company Institute.

In a recently released survey of 4,200 fund-owning households compiled in May, the institute found that only 30 percent of households were taking substantial or above-average risks - unchanged from May 2009 and down from 37 percent in May 2008.

For the past couple of years, the ICI has noticed more investor cash flowing into bond funds than riskier equity portfolios.

To some degree, this reduced tolerance for risk can be explained by the gradual aging of the population, noted the ICI's chief economist, Brian Reid. Investors generally get more conservative as they age.

But also, investor behavior is affected by what has been happening in the financial markets - meaning that investors seem to be chasing positive returns in the bond market while remaining leery about the stock market.

Investors on balance don't come across as being especially opportunistic. People who might be enticed to buy a new car or appliance with a price cut don't react the same way when stock prices drop to a discount.

According to another study, by the University of Missouri, investors seem to be growing less willing to assume risks.

Rui Yao, an assistant professor in the Personal Financial Planning Department in the university's College of Human Environmental Sciences, found that the risk tolerance of investors rises and falls with movements in the stock market. People invest more when returns are high and less when returns are low or negative.

This buy-high, sell-low tendency has been observed before, and it leads to ineffective investment tactics and unnecessary losses, she said.

"The ideal strategy is to buy stocks at a low price, with the hope of selling them at a higher price," Yao said in a statement. "However, many investors seem to be unwilling to take risks when the market is at a low point and seem content to only invest when the market is at a high point."

To assess risk tolerance over time, Yao examined research conducted by the University of Michigan dating to 1992. In that study, participants were asked hypothetical questions about various trade-offs and then were assigned to different risk-tolerance groups based on their answers. Overall responses were then compared with the status of the stock market each year.

Yao's study, published in the Journal of Economic Issues, found that many Americans are not behaving according to rational economic assumptions. She said such changes in risk tolerance in response to market returns may indicate investors, and possibly their advisers, overestimate their ability to understand risk and assess their tolerance for it.

She considers improved financial education as the best way to help people work through these issues.

To the extent more people might learn to become better investors, workplace 401(k)-style plans could be among the best venues for doing so.

Increasingly, these employer-sponsored programs have become the gateway to mutual-fund ownership and stock-market exposure.

According to the ICI's study, more than 70 percent of fund-owning households that bought their first fund within the past five years did so through a retirement plan at work. By comparison, only about half of those who made their first fund purchase at least 20 years ago did so in a 401(k) plan.

Through these programs, many employers are making third-party investment advice available for participants. Many also are enrolling workers automatically, putting them into age-appropriate default investments (usually funds with a stock component) and even boosting their contributions automatically over time.

All these steps are showing promise. They're encouraging people to sock away money and keep doing it long enough in suitable investments to make a meaningful difference over time.

by Russ Wiles The Arizona Republic Oct. 3, 2010 12:00 AM



Investors grow less apt to risk