From the March 2013 issue of Research Magazine • Subscribe!

February 22, 2013

Busting the Risk Myth of Women and Investing

New research challenges assumptions about sex differences in risk tolerance.

Women are obviously less willing to take investment risks than men, right?

A seminal study by professors Brad Barber and Terrance Odean famously found that men trade more aggressively than women within brokerage accounts. Other early studies found that women prefer safer portfolios in their defined contribution plans. The perception of the fairer sex as less willing to suffer the cruel volatility of a stock-laden portfolio fits well with common beliefs about the differences between men and women. 

But there’s more to this story. Women and men are different, but not just biologically different. Women in older cohorts were less likely to go to college, many interrupted their working lives to raise children, and others chose not to assume responsibility for managing household investments. It’s important to understand why these differences exist because an overly conservative portfolio can be just as inappropriate as an overly risky one.

Risky Reluctance

How harmful are risk-averse portfolios? Federal Reserve Bank economist Urvi Neelakantan estimates that the more conservative retirement investments of women can explain about 10% of the gender difference observed in sheltered retirement account balances. Since women live longer than men on average, they will need more money to fund the same level of retirement income. Maintaining some risk in a retirement portfolio is especially important given stocks’ more favorable risk/return characteristics when held for a long period of time. Gender differences in risk tolerance can have important social implications if women are less prepared for retirement than men.

If women are less willing to take risks than men because they are wired differently, then this difference should show up in other decisions that involve taking chances. The evidence is mixed. Perhaps no scholar has spent more time studying the question than Stockholm School of Economics professor Anna Dreber. She finds no difference in risk taking between male and female professional bridge players, but these same players exhibited differences in financial risk aversion on a questionnaire. She also finds few differences in competitiveness between school-age girls and boys in various tasks. 

Ohio State professor Sherman Hanna has studied gender differences in the Federal Reserve’s Survey of Consumer Finances and finds more evidence that women and men may not be that different. Hanna compared portfolio allocation and responses to risk tolerance questions among same-sex couples and opposite-sex married couples. Married (opposite sex) women who responded to the survey were indeed less willing to take financial risks than men. But women within a same-sex couple were just as willing to take financial risk as married men. In fact, women in a same-sex couple were slightly more willing to take investment risks than men in a same-sex couple. This throws a wrench in the biology theory.

Hanna’s most interesting finding may be that while women in same-sex couples are more willing to take financial risks, they actually hold less stock in their portfolios than married heterosexual couples. In the article, Hanna and his co-author Suzanne Lindamood wonder whether these less risky portfolios may reflect a bias on the part of financial service providers who assume that women aren’t as interested in a risky portfolio.

This is one of the dangers of placing too much weight on an early piece of research that fits our own preconceived ideas. We tend to be much more receptive to information that is consistent with what we already believe, also known as the confirmation bias. The popularity of the Barber and Odean study may have been enhanced by how well it fit conventional wisdom about gender differences—it was even titled “Boys will be boys.”

Digging Deeper

La Salle University professor Michael Roszkowski and University of Georgia professor John Grable find that the intuition of financial advisors about gender differences isn’t very accurate. The correlation between the advisor estimate of risk tolerance and actual risk tolerance (measured using a common risk tolerance assessment tool) was only 0.41. The reason advisors were not able to consistently assess the risk tolerance of their clients was that they overestimated the risk tolerance of male clients and underestimated the risk tolerance of female clients. This bad intuition is a problem that can lead to making the wrong portfolio recommendations.

According to Texas Tech professor (and neuroscience expert) Russell James, most of us prefer relying on stereotypes because they save us time and effort. It takes less time to make assumptions than it does to dig a little deeper. “Bottom line, knowing about differences in the average behavior of men and women tells you absolutely nothing about the client sitting in front of you,” notes James. “It is easy to think of yourself as being scientific by using a rule of thumb based on population averages, but it’s really just being lazy. Don’t assume.”

Hanna is cautious about placing too much weight on biological explanations of risk tolerance. “My intuition is that there are some genetic differences that tend to make women more  risk-averse than men,” he says. “But to me this may to some extent reflect an illusion that can be corrected by education.” 

A recent paper by Dreber goes a long way toward explaining why the risk tolerance gap exists despite little evidence of gender differences in risk taking. Women tend to be less financially knowledgeable than men. Previous studies linked financial literacy with stock market participation. It makes sense that if you know about the risk and return characteristics of equities, you’ll likely invest some of your portfolio in stocks. Those who aren’t as aware of the potential benefits of stocks are less likely to buy them. Dreber shows that when you control for financial literacy, differences in stock market participation almost disappear. 

The question remains: Why aren’t women as financially knowledgeable as men? Economics provides an answer. When a man and woman get married, they tend to delegate household tasks to the person best suited for the job. Women often cede financial decisions to their husbands, although there is evidence that this is changing. Using data from the Texas Tech Financial Literacy Assessment Project, we calculated the gap between financial literacy scores for men and women by age group. For baby boomers and younger age cohorts, the difference was about 10%. For those aged 65 and older, the gap widened up to 25% among women age 75-79.

Going to college gives women more than exposure to business coursework—it gives them more earning power. And more earning power means more decision-making power over investments. One of the reasons women are increasingly responsible for financial decisions is that the higher-earning spouse often takes the role of primary financial decision maker. As the gender imbalance in higher education has shifted in favor of women, so has the size of their paycheck and their control over the household’s finances. But in more traditional and older households, the primary financial decision-maker is often the man. So it makes sense that he will spend more time and effort learning about finance than will his wife.

Hanna also does not believe that previous studies have done a good enough job controlling for family characteristics that influence how much risk women are willing to take. Financial planner and Texas Tech Ph.D. Kim Bridges decided to look more closely at whether gender differences can be explained by these family characteristics. She explores the extent to which a woman’s education and work experience contribute to a greater aversion to investment risk.

Bridges suggests that one way to think of an individual’s earning ability is as a bond throwing off regular income. This bond has a value known as human capital. A man invests in education in order to increase the value of his income-generating ability. The investment for women is a little different. Many women choose to give up part of their careers to provide childcare. Some women leave the workforce for a period of time, and others take on less demanding careers. 

This sacrifice early in life has two effects. First, it reduces the value of their future earning ability. Since risk tolerance increases with both financial wealth and human capital, this can explain a preference for less risky investments. Having less money generally means you can take fewer risks. Second, the wife is more reliant on the income of the husband since his human wealth was not reduced by career sacrifices. Since a large percentage of marriages result in divorce, the wife must consider this possibility when making investment decisions. 

In her dissertation, Bridges calculated human capital for men and women. She then recycled a question from a national survey conducted during the debate over Social Security privatization that asked how respondents would invest money in private accounts. She found that women did prefer a retirement portfolio with a greater share of bonds. But when she included human capital as a variable, the preference disappeared. 

So are women more risk-averse than men? Yes, but these differences probably aren’t based on biology. Research indicates that women with the same financial knowledge and work history as men are going to want the same risk in their investment portfolios. Thinking otherwise may say more about the advisor than about the client. 

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Michael Finke, Ph.D., is a professor and coordinator of the doctoral program in personal financial planning at Texas Tech University.

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