We all like to think that we’re rational human beings, but as financial experts have found out, human beings are prone to making decisions that may not be in their best interest. A lot of that comes from miscalculating risk – as it turns out, we’re not always great at figuring out which option is the riskiest. We also hate making bad decisions, so we’ll do everything we can to avoid them. That actually makes some of our decisions even riskier! We’re much more likely to make a risky decision if we think it’ll help us avert a loss.
That’s why we thought it would be fun to test the risk profiles of attendees of last week’s FinCon. FinCon is a conference for people who meet at the intersection between finance and digital media. Or, to take away the marketing spin, a conference for personal finance bloggers, podcasters, YouTubers, and other new media stars. Would this group of financial experts be more or less risk-averse than your average person?
Click your answer to see how you compare to FinCon 2015 attendees.
Question One: If you had to choose between more job security with a small pay increase and less job security with a big pay increase, which would you pick?
A) Definitely more job security with a small pay increase
B) Probably more job security with a small pay increase
C) Probably less job security with a big pay increase
D) Definitely less job security with a big pay increase
As you can see, we gave our respondents two options for each choice above: they could either definitely want more/less job security and pay or probably want more/less job security and pay.
The majority of our respondents answered somewhere on the spectrum of choosing less job security in favor of more pay – not surprising, considering many FinCon attendees are bloggers and entrepreneurs who struck out on their own!
When you think about your own answer to this question, ask yourself, "Was I influenced by any recent events?" If you were, you may be experiencing one of life’s many biases. Availability heuristic, as this one is known, refers to our brain’s choice to place more importance on things we can remember or that happened recently. For example, let’s say one of your friends decided to quit their job and start a coffee shop, and business is booming for them! You may be more likely to choose less job security.
Question Two: When you think of the word "risk" in a financial context, which of the following words comes to mind first?
The majority of our respondents think of risk as financial uncertainty. Seeing as the word "risk" literally means that something could potentially happen, this interpretation makes sense. A smaller, but sizable, group think of opportunity when they hear the word risk - meaning they have a greater tolerance of risk and volatility. Again, this makes sense considering who attends FinCon.
Question Three: Assume that a long-lost relative dies and leaves you a house which is in poor condition but is located in a suburb that’s becoming popular. As is, the house would probably sell for $300,000, but if you were to spend about $100,000 on renovations, the selling price would be around $600,000. However, there is some talk of constructing a major highway next to the house, and this would lower its value considerably. Which of the following options would you take?
A) Sell it as is
B) Keep it as is, but rent it out
C) Take out a $100,000 mortgage and do the renovations; then sell it
The least risky choice is, of course, to sell it as is, pass Go, and collect your $300,000. Only 33% of our respondents went with the least risky choice. However, 35% would prefer to keep the house and rent it out – generally, a smart way to get a second source of income, but still risky knowing that the property value could drop considerably. The most risky choice is, of course, taking out a mortgage and renovating the house.
Knowing that some FinCon attendees are self-fashioned real estate experts, flipping houses for profit and generating passive incomes from real estate, makes it easier to understand that 31% of respondents would choose the riskiest option.
Question Four: You’re on the world’s worst game show and you have to take one of the following bets. Which bet do you choose?
A) A bet with an 80% chance of losing $4,000 and a 20% chance of losing nothing
B) A bet with a certain loss of $3,000
Almost 70% of our respondents chose to go with the riskier option for this question. Why is it riskier? In the first scenario, your expected loss ($3,200 or 80% x $4,000) is worse than the expected loss in the second scenario ($3,000 or 100% x $3,000).
Why do more people choose option A? Because they’re irrationally loss-averse. They’d rather take on the risk of losing more money if it means they have a chance of losing nothing. Interestingly, the Fincon attendees we surveyed are gma bit less loss-averse than the general population. This experiment has been run several times by behavioral economists and over 90% of people will chose option A (see Tversky and Kahneman’s work for some deep reading on this).
This is important when it comes to how people think about insurance. People often focus on the potential loss ("What if I don’t ever need it? Am I just pouring money down the toilet?) rather than the potential risk that insurance covers. In the above question, option B is insurance: you’re paying $3,000 to avoid the possibility of losing $4,000. As you can see from our survey results and other experiments, this is a major reason why most people consider insurance to be their fourth lowest ranked financial priority, behind saving for retirement, paying down debt, and sticking to a budget.
And remember all that talk about "availability heuristic"? It comes into play for insurance, too: most people are more likely to think about getting an insurance policy after an insurable event has happened. Unfortunately for those people, insurance doesn’t cover past events.
Demographics: 56% of our respondents were female, while 44% were male. 27% were between the ages of 20 and 29, 41% were between the ages of 30 and 39, 16% were between the ages of 40 and 49, 14% were between the ages of 50 and 59, and 2% were 60 or over.
How did you stack up compared to FinCon attendees? Are you more or less risk averse than these financial experts? Let us know how you responded in the comments below.