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People Fear Risks More than they Want High Returns, This is a fundamental truth of investment behavior. Let us understand this concept.
Risk categories of investors and investment options
Investors can be grouped into risk classes. For example, investors with a high risk appetite can be called high risk class, and those with a low risk appetite can be called a low risk class.
Similarly, investments can be grouped as high risk and low risk investments. Within each of the two groups – high risk and low risk investments – there are many categories of varying degrees of risk.
Whether a person prefers high-risk investments or low-risk investments, each investor is worried about how risky an investment is within his risk class.
While returns excite a person and may get him or her interested in a proposal to invest, his or her chief worry will be on how safe the money is.
Try telling a customer that an investment is risky
As a professional sales person, suppose you tell a prospect that a particular investment is not safe, do you think that the prospect will go ahead and invest his money in that very asset? Share brokers know this very well. They have to only tell their customers that a particular share is risky and most customers would not like to invest in it. But if the broker, for the same share, suggests that the company is well managed, and is likely to make profits, many of his customers will put in the money on that share. The share in both cases belongs to the same company, but pointing out the risk frightens the customer.
Mutual fund agents do not mention the risks while selling
This is the reason why the mutual fund agents do not talk of risks. This is also why mutual fund organisations hide behind a blanket statement: Mutual funds are subject to market risks. No one ever explains what those risks are, except to mention: Read the offer document. If one takes the trouble of actually reading the offer document, (which no one really does) the layman will not understand anything because of the technical language used.
Suppose there were 2 prospects sitting in front of you. One is highly risk averse (does not want to take risks), while the other wants to take risks. And suppose you told the first person, who is risk averse, that a particular equity fund of a mutual fund is risky investment because the market is currently very turbulent or volatile. The chances are that he will take your advice and will not invest.
What about the person with a higher risk appetite, the one who does not mind taking risks? He will also have the same answer. Because you have told him the plan is risky.
Investors minimize risks within their risk class
Different persons in different risk categories will want to minimize the risks within their risk-class. Whether he is a big businessmen or whether he is a salaried person. This is the reason that serious investors study investments before making the investment – they all want to minimize their risks.
What does this tell you? People fear risks more than they want returns or income, irrespective of the risk class they belong to.
People of a particular risk category will not expect the returns of another risk category
We may invest in land in the expectation that land prices will double in 3 – 4 years, but we do not put money in a bank in the hope that our money will double in 3 – 4 years’ time. A person investing in a bank fixed deposit knows that he will not earn more than the investor in land. This is not to suggest, however, that the person investing in land will always earn more than the fixed deposit holder. It does not also mean that a person investing in land will not invest a part of his or her savings in a bank. All investors put their money in a variety of assets.
This is another fundamental understanding of customers and their attitude to risk and returns.
- A low risk investor will expect the low returns; a high-risk investor will expect high returns.
- A high-risk investor will not expect low returns in a high risk investment;
- A low risk investor will not expect high returns associated with a higher risk category
This is an important understanding of the concept of risk behavior of individuals. You have often asked yourself why a person should invest in conventional insurance if he can potentially expect high returns in mutual funds.
People invest in conventional insurance because they want to belong to that risk class, they do not want the risk class or the return expectations of a higher risk category such as mutual funds. Everyone understands that money does not grow on trees.
Individuals do not want high returns. They want the highest returns within the risk class they belong to. So an investor looking for long term investments in conventional life insurance endowment will shop around for the endowment that gives the best bonus, subject to other considerations of trust and customer servicing. A low risk investor who wants to invest funds for the short term, will look around for the bank or post office that offers the best interest rate, subject to considerations of convenience of banking with that particular bank or post office. These investors will not see mutual funds as an option for conventional life insurance endowment or banks. Investors making an investment in mutual funds are doing so because they are willing to take risks in investments. The investment in mutual funds is not an alternative to life insurance or banks. It is a separate investment decision taken on the basis of the investor’s risk appetite.
Implications for life insurance selling
Since a person belonging to a lower risk class will not seek the returns of a higher risk class, we should altogether avoid claiming that life insurance products give high returns. Instead we should talk of the risks associated with other investments. This is our strength. Very often we meet customers who say that they want to earn high returns. By making this statement, what they mean is that they want to get the highest possible returns in their risk category. In order to prove this to yourself, discuss the risks of investment products where the risk is higher with your customers. Remember 90 % of all money saved by Indians is in low risk.
Sell Risks Not Returns
Returns are Uncertain Risks are Certain
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