‘Disturbing’ music may influence us to take fewer financial risks…

In the second scenario, participants had to choose how they’d diversify their funds between three assets, each of which offered a 50-50 chance of getting one of two rates of return:

In the second scenario, participants had to choose how they’d diversify their funds between three assets, each of which offered a 50-50 chance of getting one of two rates of return:

It depends upon your definition of safety. Look at the mean and spread between the mean and the extreme.

Low High Mean Spread
8 12 10 2
4 24 14 10
5 5 5 0

If your definition of safety is ONLY the highest mean you will choose B, regardless of the large spread and high-risk potential for loss. The security that best exemplifies this is the “Saul-type” high-growth stock which has high volatility.

If your definition of safety is the potential for some gain at the risk of a relatively small loss, you will choose A. The security that best exemplifies this is the low-beta stock which may have slow growth and perhaps a dividend. If the stock market drops this kind of stock will fall less.

If your definition of safety is absolute certainty and ZERO potential for loss, and you don’t care about the potential for gain, you will choose C. There are many, many people who need securities of this type – the best example is the I-Series Savings Bond which is inflation adjusted but currently has no yield above the inflation rate. I would say “cash” except that cash is currently losing value due to high inflation.

Every investor needs to think about their own financial needs and emotional risk tolerance and choose a mix of A, B and C that will best satisfy their situation.

It is not “innumeracy” to decide that certainty is more important than taking on risk for the chance of gain, for part (or all) of a portfolio, depending on the investor’s needs.

The whole point of the Israeli study was how music influenced risk-taking. Choice C is zero risk.

Choice A: 8 percent, 12 percent Choice B: 4 percent, 24 percent Choice C: 5 percent, 5 percent — The whole point of the Israeli study was how music influenced risk-taking. Choice C is zero risk.

I think you missed the fact that there is a 50:50 chance of either outcome and no zero (or negative) return outcome. Choice C is a guaranteed 5%. Choice A is also zero risk, in that you will either get a higher return of 8% or 24%. Choice B has a slight opportunity cost (4% instead of 5%) but also you may get the highest 24% return.

<I think you missed the fact that there is a 50:50 chance of either outcome and no zero (or negative) return outcome. Choice C is a guaranteed 5%. Choice A is also zero risk, in that you will either get a higher return of 8% or 24%.>

OOPS, you’re right. I didn’t notice that . My bad!
Wendy

A is for people who like medium returns and lower risk
B is for people who like high returns and higher risk
C is for nobody except the innumerate … but tons probably choose it because they like paying high fees for no variance and believe the people who charge those high fees when they tell them that variance, and variance alone, is risk.

C makes no sense whatsoever when compared to A. It’s like a hedge fund where you are paying 3% of your gains in fees when the total gain is 8%, and paying 7% in fees when the total gain is 12%.