Encouraging Risk-Taking: The Challenge of Long-Term Financial Planning

The Financial Conduct Authority (FCA) has set out a five-year strategy to encourage greater risk-taking and investment in productive assets by UK savers—in line with the Government’s plan to promote economic growth. One area of focus is retirement planning, where many people are reluctant to take investment risk.

A key challenge is that many individuals fail to grasp the link between taking risk in their pension fund and the long-term growth which a diversified portfolio can deliver. Instead, savers tend to prioritize the avoidance of short-term investment losses, often resulting in excessive cash holdings that fail to generate the returns needed for financial security. A Pensions Institute report, based on a large UK population sample, highlighted this issue back in 2014, and little evidence suggests that attitudes have shifted significantly since then.

Stability in risk attitudes

A2Risk regularly surveys the UK population using our well-established Attitude to Risk Questionnaire (ATRQ). Our findings consistently show that attitude to risk (ATR)—or risk tolerance—increases with income levels, and that women tend to be more risk averse than men¹. Beyond these factors, age and other demographic variables play a much smaller role in determining risk preferences.

Still, the overriding finding from our ATRQ is that UK savers are fairly risk-averse. Our survey data indicates that 20% of people with an average income or higher would be very uncomfortable with any decline in their investments. Furthermore, the majority of respondents would be uneasy with losses of even 10%, and only 15% would not feel very uncomfortable if their investments fell by more than 20%. This is a scenario that growth assets like equities—and other productive assets that the Government wishes to encourage—are likely to experience over a typical 5-10 year investment horizon, despite the potential for the returns on these assets to exceed those on ‘safer’ assets in the long run.

What is particularly striking is the stability of ATR over time. Despite various economic events—including the COVID-19 pandemic and the ongoing cost-of-living crisis—risk attitudes have remained largely unchanged. This presents a challenge for financial advisers over whom the FCA has oversight. They may well be keen to help deliver the FCA’s strategy—which is called ‘Deepening Trust. Rebalancing Risk. Supporting Growth. Improving Lives’—by encouraging greater investment in growth assets by their customers, but they find themselves working within the constraints of deeply ingrained risk preferences.

The policy challenge: attitude to risk, capacity for loss and goals.

A customer’s investment strategy depends on risk tolerance and goals—and their investment horizon.

Risk tolerance has two key components: Attitude to Risk (ATR) and Capacity for Loss (CFL). ATR—being more psychological in nature—seems hard to shift using policy levers. CFL depends on each customer’s circumstances, such as income or other resources that can support them if their assets fall in value. CFL is generally greater the longer the investment horizon.

A policy designed to increase risk-taking might be more effective if it focuses on goals rather than directly altering risk attitudes. For instance, innovation aimed at younger customers—with their naturally longer investment horizons—could help them better understand the benefits of taking long-term investment risk and the trade-offs involved. One key trade-off is that the higher average returns from investing in growth assets results in lower contributions to meet specific future goals—such as a higher retirement pension or earlier retirement—despite greater shorter-term investment volatility.

Encouraging a shift in perspective

If financial resilience and better long-term investment strategies are to be encouraged, new approaches will be needed. Simply expecting policy changes from the top to alter ingrained attitudes is unlikely to succeed. Instead, fostering a clearer understanding of long-term goals, trade-offs, and the risks of inaction may be key to helping individuals make better financial decisions.

Innovation in financial education and investment solutions—particularly those that help younger individuals embrace the necessary level of investment risk—could play a crucial role in shifting the conversation. By equipping consumers with the tools to make informed decisions, there is hope that more people will take the necessary risks to secure their financial future—as well as helping to promote the economic growth that the UK so desperately needs.

1. However, gender differences in risk aversion tend to disappear when controlling for other factors, such as income differences. See, e.g., David Blake, Mel Duffield, Ian Tonks, Alistair Haig, Dean Blower and Laura MacPhee (2022) Smart defaults: Determining the number of default funds in a pension scheme, British Accounting Review 54 (2022): 101042; https://www.sciencedirect.com/science/article/pii/S0890838921000688 ↩︎