Risk Aversion

You may have heard about the structural differences that have been discovered between men and women’s brains. What you may not know, however, is that differences in brain activity may lead the genders to perceive risks in life differently, which also has implications on investing behavior.

One of the findings of the recent BlackRock Investor Pulse survey of 4,000 Americans, for instance, is that women are generally more risk averse than men when it comes to saving and investing.

While greater risk aversion can help investors avoid unnecessary risks and losses from short-term gambling in the stock markets, women who concentrate their investments in lower-risk assets, such as cash and fixed income securities, while shunning the riskier equity markets, risk falling short of their retirement and other long-term financial goals.

Greater risk aversion, the focus of this post, is just one of three key ways women investors tend to differ from their male counterparts. As a new contributor to the BlackRock blog focusing on behavioral finance, I’ll be covering these gender-related behavioral differences in a series of posts. I’ll be examining the research behind them and what people can do to mitigate their potential negative financial impact. To start, here are my responses to three questions you may have about women’s tendency toward greater risk aversion.

Q: What evidence is there that women tend to be more risk averse?

A: Beyond the BlackRock survey I mentioned above, multiple experiments and studies in sociology, psychology and finance have shown that women and men tend to respond to risks differently, with women generally more risk averse.[1] Gender differences have been found in attitudes toward risks associated with recreational and social activities; risky behavior such as neglecting to wear the seat belt; smoking, alcohol and illicit drug use; criminal activities; and finally, decisions about portfolios.

In regards to portfolios, experimental evidence and field data (for example, from the Federal Reserve’s (Fed) Survey of Consumer Finances, and on defined contribution pension allocations) suggest that women hold a greater share of their assets in lower-risk investments than men. And the greater risk aversion isn’t just expressed in portfolio composition. Women also tend to express more concern when financial market volatility increases, and are likely to take more time to make investment decisions.

Q: Why are women more risk averse?

A: To explain the differences in risk aversion, some researchers point to economic and evolutionary reasons, while others have focused on how individuals evaluate the likelihood of potential financial outcomes, or wealth resulting from different investment options. A very interesting study found that while women and men do not differ in their perception of possible gains or losses, women tend to be more pessimistic about the probability of high likelihood gains than men. This effect is illustrated in the figure below.

Figure 1: Perceived probability of gains vs. true probability by women and men

Figure 1

Figure 1 shows the perceived probability of gains w(p) by men and women relative to the objective probability of gains p. An unbiased individual would be positioned on the straight line, perceiving the likelihood of a gain to be in line with the true likelihood. The further down the perceived probability line w(p) drops below the straight line, the more pessimistic the individual is about that likelihood gains. For higher likelihoods, women’s perceived probability line w(p) lies below that of men’s, i.e. women are more pessimistic about the likelihood of gains.

 

A possible reason for female pessimism has to do with what has become known as the risk-as-feelings hypothesis. Most modern finance theory assumes that people make probabilistic assessments rationally, without the interference of feelings or emotions. In reality, psychology studies have found that emotions often diverge from these purely cognitive assessments, and whenever there is a discrepancy, emotions tend to dominate. Moreover, emotions are often affected by factors such as vividness of imagery. Women tend to report stronger mental imagery than men and experience nervousness and fear more pronouncedly. This may result in women underestimating the probability of high likelihood gains, and exhibiting more pessimism when faced with risky decisions.

Q: How can women potentially overcome the detrimental investing impact of greater risk aversion?

A: Being aware of the bias is a start. It may also help to work backward from longer-term goals (think buying a home or being able to afford a good college for children) to highlight any funding shortfalls that taking on more risk may potentially overcome. Finally, diversified products such as exchange traded funds as well as portfolio construction techniques and products designed to provide some downside protection, such as minimum volatility strategies, may help women increase their comfort with riskier assets.

 

Nelli Oster, PhD, is a Director and Investment Strategist in BlackRock’s Multi-Asset Strategies Group. She holds a BSc (Hons) in Management Sciences from the London School of Economics and a PhD in Finance from the Stanford Graduate School of Business, where her dissertation focused on behavioral finance.

 



[1] In finance, a risk-averse investor, when choosing between two investments with the same expected return but a different degree of riskiness, as measured by return volatility and correlation with other assets, prefers the investment with lower risks.