Michael A. Guillemette

Don't Like the Picture, Change the Frame: The Effects of Framing and Cognitive Ability on Risky Choice

This paper identifies the effect a perceived up-front cost has on subsequent risky choice of older Americans. When respondents are faced with outcome alternatives framed in an up-front cost and no up-front cost domain, we observe variation in the respondents’ required outcomes based on the order in which the two domains are presented. We provide evidence that among respondents with lower cognitive ability, losses need not be realized to affect subsequent risky choice, and that an up-front cost lowers the willingness to take risk in a future period. Implications for annuitization demand are discussed.

Loss Aversion Under Cognitive Load

An experiment was conducted to explore whether loss aversion is altered when individuals are placed under a higher level of cognitive load. The coefficients of monetary loss aversion were measured for 30 participants under low and high cognitive load. Memorizations of differing spans of digits were used to manipulate cognitive load. Participants’ skin conductance was measured to quantify emotional responses to gains and losses. No statistically significant evidence was found that loss aversion, as measured by choice, is altered when individuals are placed under a higher level of cognitive load. Statistically significant evidence was found that a higher level of cognitive load temporarily reduces an individual’s emotional arousal to absolute and relative small dollar losses.

What Determines Risk Tolerance

It is important for financial planners to understand what drives risk tolerance as it directly influences the portfolio allocation preference of clients. Possible explanations for determinants of risk tolerance include habit formation, loss aversion and investor sentiment. We hypothesize that these three factors account for significant variation in risk tolerance. We analyze average monthly scores from a widely used risk tolerance questionnaire that spans the global financial crisis (January 2003 - December 2010). We find that the habit formation, loss aversion, and sentiment proxies account for -1.06%, 38.51% and 13.21% of the variation in average monthly risk tolerance, respectively. Habit formation did not account for additional variation in average monthly risk tolerance when controlling for loss aversion and sentiment. Implications for financial planners are discussed.

The Effect of Advanced Age and Equity Values on Risk Preferences

ABSTRACT The authors analyze the effect equity values and age have on the risk aversion of participants in U.S.-defined contribution plans using a unique dataset with daily responses to a risk tolerance questionnaire. They find that older investors are more risk averse compared with younger cohorts when controlling for the level of the S&P 500 Index, account balance, income, savings percentage, equity percentage and allocation fund percentage. They also find that risk preferences are influenced by the level of the S&P 500, but only in advanced age. This finding is consistent with decreasing absolute risk aversion when wealth is proxied by the S&P 500 Index.

The effect of investment and withdrawal horizons on myopic loss aversion

ABSTRACT Using unique survey data, we find that a longer investment horizon (6–10 years and 11+ years) reduces the likelihood of exhibiting myopic loss aversion (MLA) compared to an investment horizon of less than 2 years. In addition, we find that investors with higher levels of assets under management (AUM) are less likely to exhibit MLA compared to the lowest AUM quartile.

The effect of disability income on retirement decisions and wealth

ABSTRACT Using the 2008 National Longitudinal Survey of Youth, this study examines the impact of receiving disability income on a respondent’s decision to calculate a retirement income need, use tax-advantaged accounts and accumulate retirement wealth. Respondents who received disability income were 4.4% less likely to report calculating a retirement income need and 4.5% less likely to report using a tax-advantaged account, compared to a reference group of respondents who did not receive disability income. Respondents who received disability income also accumulated 41% less retirement wealth compared to the same reference group.

How Nobel Laureate Richard Thaler's Work Impacts Financial Planning

This short paper provides an overview of some of Richard Thaler’s research findings and applications to the field of financial planning.

Who Exhibits Time Varying Risk Aversion

There is growing empirical evidence that risk preferences change based on financial market conditions. This paper explores individual predictors of time varying risk aversion among participants in U.S. defined contribution plans using a unique dataset with daily responses to a risk tolerance questionnaire. We find that older investors (ages 51-65) are more susceptible to time varying risk aversion. Among older investors, variable risk preference was greatest for participants with the smallest account balances and the lowest incomes, but was unrelated to equity allocation within their retirement portfolio. Much of the variation in the aggregate risk tolerance score can be attributed to variation in future long-term equity performance expectations among older investors. We discuss how target-date funds have the potential to reduce losses from poor market timing that may result from time varying risk aversion.

Neuroscience and Consumer Finance

Developments in neuroscience research methods have allowed for considerable advancements in our understanding of the role of various parts of the brain in making decisions, and specifically, in making financial decisions. Of particular interest, research using functional magnetic resonance imaging (fMRI) analyzes changes in blood flow to various parts of the brain, which corresponds with an increased use of that area of the brain. fMRI research has discovered a great deal about the neural environment in which individuals make financial decisions. This chapter provides an overview of neuroscience and neuroscience research methods and highlights recent neuroscience research findings related to a variety of financial decisions consumers face, including purchase decisions, investment and portfolio management decisions, and choosing a financial advisor.

The Effect of Certification on Investment Decisions

Forty-six participants were endowed with real money and received hypothetical investment advice from a CFP® Professional and a stockbroker. Results indicate that among low-income households, advice from a CFP® Professional influenced investor choice behavior within hypothetical education and retirement savings accounts. Statistically significant results indicate that when participants made investment decisions using education funds and received advice from a CFP® Professional, the mean expected value of their investment choices was