Game Theory and your Risk Preference
Game Theory is the study in which choices produce outcomes when viewed in terms of preferences, the final outcome may not be the outcome the individual was hoping for. The result is of decisions taken by the individual. Unknown variables play a part in the end result.
We make decisions every day, most seem insignificant however the thought process behind making the decisions is something worth considering. Easy examples: morning herbal tea or can of coke, cross the road or wait for the light to turn green. Then take a larger decision such as choosing a college course, this decision defines your attitude to risk at that point, do you pick a course that will lead to a secure job versus what you love but run the risk of not making a decent living to support yourself. What factors did you consider most important when making that decision?
An individual who is Risk Averse opts for lower returns with known risks, they are the people who will always wait for the traffic lights to turn green, although this of course is the more secure option there is still a slight chance that this play be unsuccessful, it just takes one driver to run a red light. The Risk Averse individual chooses a college course based on the statistics of recruitment on graduation, in hope that market conditions remain the same. In investment terms capital security drives their decision making. These individuals’ goals and preferences are the opposite of risk takers.
Risk Takers will watch the flow of traffic and pick their spot and risk being run over. They opt for the college course in a niche area as they have the self-belief that they will make a success of themselves regardless of market conditions on graduation. A risk taker in investment terms strives to achieve higher returns regardless of the potential loss or downswings they may face. They will not lie awake worrying, they enjoy the unknown as that is in line with their natural tendencies. Provided that their strategies work most of the time, belief in their decisions offsets panic in times of market Volatility.
Both of the above strategies have merit, however most individuals fall somewhere in the middle of the two above extremes. The ESMA (European Securities and Markets Authority) volatility scale attempts to measure an individual’s risk preference, providing a rating between 1 and 7, where 1 is low risk and 7 is high risk. This takes a snapshot of an individual’s preferences on that day. At Metis Ireland we pay particular attention to our client’s lifestyle goals and capacity when recommending a suitable investment strategy.
Game Theory, how comfortable are you with how your decisions play out? Are there patterns in how you reach decisions? Unknown variables will have a greater effect on the results of risky decisions. Both individuals and markets are irrational. It is easy to take risks when markets are performing well, however when prices fluctuate does your optimums and belief hold? Pay attention to your tendencies, this should play a part when setting appropriate investment return goals. Figuring out your investment risk profile can seem like a daunting task. We can help you through this process. Feel free to give us a call on 061 518365.
Metis Ireland Financial Planning Ltd t/a Metis Ireland is regulated by the Central Bank of Ireland. All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice. You should always engage the services of a fully qualified independent financial adviser before entering any financial contract. Metis Ireland Financial Planning Ltd t/a Metis Ireland will not be held responsible for any actions taken as a result of reading these blog posts