How misinterpreting risk impacts financial returns

Emma Wall  |  28/03/2017Text size  Decrease  Increase  |  

Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Prof. Gerd Gigerenzer to talk about risk.

Hello, professor.

Prof. Gerd Gigerenzer: Hello.

Wall: So, I suppose the first question we should start with is, what is risk.

Gigerenzer: Now, if you are in a world of certainty, there is no risk, but most of the time we are not in the world of certainty. And risk is usually a term meant for a situation where you can fairly know the probabilities as opposed to uncertainty. That's risk. So, for instance--and the problem is that many people don't understand risk and also try to mislead you.

The Worth Health Organization recently informed us and warned us that for every 50 gm of sausage we eat your risk of getting colon cancer increases by 18 per cent. Many of my friends stopped eating sausage because they believed. So, out of 100 people 18 will get colon cancer? No, it was a trick.

The risk increased from lifelong about 5 per cent to almost 6 per cent. That wouldn't cause much fear. But instead of saying 1 percentage point or less 1, it's 18 per cent. So, 5 per cent to 6 per cent would be 20 per cent, it's less at 18 per cent. And it's a common trick. It works for most people and we can steer their emotions and their behaviour.

Wall: And how does this misinterpretation of risk impact investors and their portfolios?

Gigerenzer: We know from studies that even professional brokers and people who are in the investment business do not really always understand what volatility means. So, one study in the US, in New York, showed that most professionals confused volatility with the average deviation. Volatility is the standard deviation, which is larger, so they underestimated volatility. It's one example.

Another one is that the general public is not financially literate with very few exceptions and I think we need to do something about that that we create a society where people can make informed decisions and we are not there and we do very little about that.

Wall: That was going to lead on to my next question is, what can we do harnessing what we know about behavioural science perhaps to make sure that we don't come a cropper when misinterpreting risk?

Gigerenzer: One thing to do is, start early, say, in school. And our children learn lots of things, few of them they will need in the rest of their lives. But how to deal with money, how to deal with health, how to deal with digital media to control this rather than being controlled, those will be important things. And if only some investment firms would invest in the education of the own general public, that would be wonderful.

Wall: Professor, thank you very much.

Gigerenzer: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

Video Archive...

Schroders stays hot on commodities, cooler on tech and defensives
01/05/2017  Long-term investors in Australian shares will continue to find value, but the time for risk-taking on more speculative plays has passed, says Martin Conlon, Schroders’ head of Australian equities
Introducing star ratings to Morningstar Australasia equity research
27/04/2017  What investors can expect from Morningstar's roll-out of its star rating methodology across Australian and New Zealand stocks, as explained by the regional director of equity research, Adam Fleck.
French elections: Macron versus Le Pen
26/04/2017  Following the first round of the French Presidential elections, the 7 May vote is now between Emmanuel Macron and Marine Le Pen. What does it mean for investors?
How climate change will impact your portfolio
20/04/2017  Ignore climate change at your portfolio's peril, says Jeremy Grantham, founder of asset manager GMO.
How dwindling resources will push up commodity prices
13/04/2017  Jeremy Grantham, renowned investor and founder of GMO, explains how a growing population is putting a strain on global resources.
How retirement spending affects withdrawal rates
10/04/2017  Data shows that the withdrawal rate gets higher as spending decreases in retirement, says Michael Kitces, a US-based financial planning expert.
What lies ahead for mining and materials
10/04/2017  Iron ore, coal, lithium, and uranium: some end-markets will rise and others will fall behind, says Morningstar commodities and resources analyst David Wang.
The evolution of multi-asset investing
07/04/2017  More difficult market conditions in a rising interest rate environment highlight the value of active management across your portfolio, says Simon Doyle, Schroders' head of fixed income and multi-asset.
When is the right time to buy stocks?
29/03/2017  Davis' Associates Chris Davis says the best time to invest is when you have the money, and to ignore market "noise".
How misinterpreting risk impacts financial returns
28/03/2017  Dr Gerd Gigerenzer says fund providers need to invest in education so that savers are better equipped to deal with risk--and can make better financial decisions.
Are European stocks overvalued?
27/03/2017  Isabel Levy of French asset manager Metropole Gestion explains how she uses fundamental industrial analysis to avoid value traps and identify the fair value of European equities.
Which funds are worth paying for?
23/03/2017  High active share funds--that is, those managers who take off-benchmark bets--outperform those which are low active share. So, ban closet trackers from your portfolio.
Bond market wobbles no cause for panic
21/03/2017  Australian bonds see only a slight tremor in response to the Fed's rate rise, says John Likos, Morningstar's senior credit analyst, who also provides insights on the new, and anticipated, hybrids from Australian banks.
ESG: Essential steps for successful long-term investing
21/03/2017  Want sustainable long-term returns? Morningstar UK reveals the essential components and the fund providers who are getting it right.
Few values left in global stock market
20/03/2017  Morningstar's directors of equity research think investors need to be cautious in the market today and offer some of their best investment ideas.
Why the time is right to invest in emerging markets
20/03/2017  Hilde Jenssen from Norwegian fund manager Skagen admits that emerging markets have disappointed investors over the past three years--but says valuations are attractive and reforms are boosting returns.
Johnson: Fed's path may not be smooth
16/03/2017  The Fed's plan for stair-step rate hikes in the coming years will likely be derailed by economic reality, says Morningstar's Bob Johnson.
First-half 2017 earnings season insights
15/03/2017  Companies produced reasonably good results overall with only a few standouts, even as a cost-out theme dominated, says Peter Warnes, head of equities research, Morningstar.
The growing appeal of LICs
06/03/2017  The popularity of listed investment companies is on the rise once again, but there are several things investors need to be aware of before buying in, explains Michael Malseed, Morningstar senior analyst, manager research.
Earnings season wrap: BHP exercises good cost control
27/02/2017  As the curtains close on the 1H17 reporting season, BHP books earnings that are slightly softer than expected, while Woolies takes market share at the expense of margins.