In a study titled “Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments,” Shlomo Benartzi and Richard Thaler, professors at the Anderson School at UCLA and the University of Chicago, respectively, studied a group of defined contribution plan participants. The participants were divided into two groups and each group was told they could choose between only two funds, A and B. They were then given some information about the historical returns of these funds and were asked to decide, based on this information, how much of their retirement money they would invest in each fund. The returns for the funds were derived from actual stock and bond returns. The manipulation in the experiment was the manner in which the fund returns were displayed.
One group was shown a distribution of one-year returns for both stocks and bonds. The other group was shown a distribution of 30-year returns. The academics predicted that subjects viewing the one-year chart would invest less in stocks than subjects viewing the 30-year return chart. They based their forecast on the fact that the one-year chart accentuated the perceived risk of investing in stocks. They stated that over a one-year period, the likelihood of stocks underperforming bonds is about a third, while over a 30-year period the likelihood is about 5%.
The results found that the group looking at the distribution of one-year returns allocated their portfolios much more conservatively: 60% to bonds and 40% to stocks. In contrast, the group that saw the 30-year return distribution allocated their portfolios more aggressively: 10% to bonds and 90% to stocks. Exposure to frequency of returns tends to affect an investor’s tolerance for risk.
Source: Shlomo Benartzi and Richard H. Thaler, “Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments,” Management Science, March 1999, Vol. 45, No. 3, pp. 364–381. The returns for the funds were derived from the CRSP (Center for Research in Security Prices, Booth School of Business, The University of Chicago) value-weighted NYSE index for stocks and Ibbotson's annual returns on five-year government bonds.
Jim Lorenzen, CFP®, AIF®
Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors.
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