SAN DIEGO—Investors' experiences with financial events strongly color their view of future investments, including their risk aversion and tolerance, said Ulrike Malmendier, Ph.D, professor of finance and economics at the University of California, Berkeley. Malmendier was the keynote speaker at REISA's Spring Symposium here yesterday, and in her address—and immediately following in her breakout session “The Impact of Behavior Economics on Investor Decision-Making”—she said that those who have had positive experiences with financial events over the course of their lifetime tend to have more risk tolerance than those who have had negative experiences. This can impact their investment behavior significantly.

“Personal experiences affect a person's willingness to take financial risk,” said Malmendier. “The Great Depression in the 1930s impacted risk aversion for the rest of people's lives.”

Recent positive or negative experiences can also impact investment decisions, but the effect dissipates over time, Malmendier said. Also, she noted a higher rate of stock-market participation and risk tolerance in younger vs. older households, since the latter have experience with stagflation and inflation during the 1970s. “Some of what we thought was age specific is actually experience specific.”

When putting together an investment package for individual investors, Malmendier advised broker-dealers to avoid overgeneralizing based on age; instead, relate it more to the individual's experiences and outlook on risk. Also, be aware that investment patterns tend to be very similar across asset classes. It's worth the time and effort to figure out an investor's whole lifetime experience when considering investment opportunities for them.

In addition, Malmendier said the psychological concepts of risk and risk assessment are important since they can move markets and change equilibrium on a grand scale. Advisors can try to shorten risk-averse cycles by sitting down with investors to reeducate them on the realities of investing after a negative financial event such as the recent recession, and this can help shorten the cycle—although lawyers caution not to make misleading or overpromising statements in doing so. Considering investment insurance is one way to mitigate negative feelings about investment, she said.