How Much Risk Are Consumers Willing to Take? MacroMonitor Marketing Report Vol. VII, No. 3 March 2005

Now more than ever, consumers are taking on risk (knowingly or unknowingly) as they become more active with stocks and instruments based on stocks such as mutual funds, variable annuities, and insurance with cash value. Before the 2000 stock market correction and the prolonged economic downturn that followed, many consumers did not realize how much risk they were taking with their investments. Four years after the peak of the stock market bubble, the 2004 MacroMonitor data reveal that consumers are more aware of the risks associated with their financial affairs.

Risk-Return Trade-Off

Figure Risk-Return Trade-Off

This report highlights the changes in consumers' attitudes toward risk over time. In light of the current national debate about privatizing personal accounts associated with Social Security, a critical question that legislators should resolve is whether Americans—particularly those people who are inexperienced with investing and who typically have trouble making ends meet—would be willing to take on the associated risk of managing their own Social Security investment account.

Given the attitudinal analysis of the MacroMonitor data, future consumer behavior regarding the financial markets will be colored by the following observations:
  • The recent steep downturn of the markets sensitized many consumers to the meaning of risk and result in a general decline in consumer receptivity to risk.
  • A time lag exists between external events and consumer reactions.
  • Income rather than age generally determines receptivity to stocks and aversion to risk.
The MacroMonitor's underlying demographic data show that not all households are willing to take on more risk. Moreover, those households that are not willing to take on risk are precisely the group that private Social Security accounts target. Given their attitudinal responses, it is hard to imagine households in the least affluent strata willing to take on substantial risk even with the additional opportunity of substantial gain.

Consumers have learned that what the markets give, the markets can take away. At this time consumers appear to be taking a break from investing and focusing instead on paying down debt and spending on current needs. Going forward, financial providers need to overcome the consumer inertia and malaise that have set in.

Whatever the outcome of the Bush administration's Social Security plan, the basic economics of the U.S. financial system will push the average consumer to take more risk. Financial providers can help consumers manage the inevitability of risk by providing incentives for consumers to take responsible action. As other studies have shown, defaulting to enrolling people into plans and programs (especially those that involve automatic payroll deductions) increases participation in retirement and other investment accounts. Creating such types of incentives could help households become more active in stocks at an earlier stage of their life when the advantages of time mitigate the risks and increase the chances for them to achieve their long-term financial goals.