The Role of Experience Sampling and Graphical Displays on One's Investment Risk Appetite

TLDR

Financial professionals have significant discretion in how they communicate investment product risk to clients. The study introduces a new risk tool and examines how different risk presentation modes affect investors’ risk‑taking behavior and recall of risk‑return profiles. The authors compare four risk communication formats—numerical descriptions, experience sampling, graphical displays, and a combined risk tool—by having participants allocate between a risky and a risk‑free fund in an experimental portfolio. Risky allocations were higher in the risk tool and experience sampling conditions, linked to lower risk perception, higher confidence, and lower loss‑probability estimates, while participants using the risk tool recalled expected returns and loss probabilities more accurately and reported no greater dissatisfaction or change in subsequent risk tolerance.

Abstract

Financial professionals have a great deal of discretion concerning how to relay information about the risk of financial products to their clients. This paper introduces a new risk tool to communicate the risk of investment products and examines how different risk presentation modes influence risk taking behavior and investors’ recall ability of the risk-return profile of financial products. We analyze four different ways of communicating risk: (i) numerical descriptions, (ii) experience sampling, (iii) graphical displays, and (iv) a combination of these formats in the ‘risk tool’. Participants receive information about a risky and a risk free fund and make an allocation between the two in an experimental investment portfolio. We find that risky allocations are elevated in both the risk tool and experience sampling conditions. Greater risky allocations in the risk tool are associated with decreased risk perception, increased confidence in the risky fund, and a lower estimation of the probability of a loss. In addition to these favorable perceptions of the risky fund, participants in the risk tool are more accurate on recall questions regarding the expected return and the probability of a loss. We find no evidence of greater dissatisfaction with returns in these conditions and observe a willingness to take on similar levels of risk in subsequent allocations.