August 27, 2019

Risk & Its Effect On Consumer Behavior

Suresh Sadagopan
CEO, Ladder7 Wealth Planners Pvt. Ltd.

Risk & Its Effect On Consumer Behavior

Consumer behavior is a very important area to understand to ensure compliance & ultimately get good outcomes.

Risk compensation, additional risk assumption & risk misperception when the risks come down, are some rather puzzling behaviors which we see all the time.

Risk mitigation is an important part of ensuring a steady life. It is important to cushion against shocks, in all areas of life.  However, whenever a risk mitigation measure is taken, we have also found that people overreach themselves & actually take more risks. They get into the Risk compensation mode.

For instance, it has been found that those wearing helmets while riding bikes tend to be rougher riders as compared to others. That is because those wearing helmets tend to now take more risks.  Seat belts similarly make the drivers speed & take tighter turns.

So, risk mitigation tools are not always as effective as they should be when it comes to outcomes. And that is the paradox. It works like this in many areas of life.

The other thing that happens when the risk in one area comes down for a person is that they don’t seem to be happy there. They invariably assume more risks. Additional risk assumption hence is the other important consumer behavioral paradox.

Also a lot of times, we do not perceive the risks that are very much there. That is Risk mis-perception.

We will be dealing with these three paradoxes as it applies in real life.

Children – Parents want to do everything for their children, give them the best & cushion them from the harsh realities of life.  This is a classic risk mitigation mechanism.  But what really happens?

They accompany their children everywhere, robbing children of initiative & inhibiting their learning by doing everything for them. The children operate in an environment where they pretty much get everything, without so much as lifting a little finger. Their social interaction skills are stunted as they are exposed to a carefully curated audience!  They tend to develop elitist attitudes that work against them in their interactions with the real world.

The children get used to fancy schools, AC classrooms, private tuitions, access to pricey learning aids, fancy toys/ clothes, etc. Many children do capitalize on the advantages conferred on them & score well. But does this prepare them for the real world? Hardly.

They are in fact unfit to operate in the real world of grime & hard work. They want sanitized environments like their parents provided them. But that is nowhere to be found. The outcome is that the children find themselves unsuited in most areas of life – work, relationships, money, etc.

Parents compensation for risks the child would be exposed to actually creates problems for their wards later.

Work – When things are going very well, people tend to do certain things which jeopardize everything they have. Is that boredom, hubris, search for challenges – we don’t know.

Here they may be compensating by taking unwanted risks when the risks for them goes down.

We have seen people at the height of their careers taking unwanted risks. For instance, they gamble by moving to another firm even though they are doing fine, are well regarded & rewarded in the company they work.

Some want to push their luck by embarking on an entrepreneurial venture with huge risks & uncertain payoffs. There are others who indulge in an ill-fated fling with a colleague, which can jeopardize their careers.

It is almost as if they do not want to enjoy the good life they are endowed with!

Money – Similar thing happens with money.  When a person invests somewhere & makes money a few times, the person gets a feeling of invincibility & their perception of risk becomes skewed. This is risk mis-perception. This is what happens in a rising market where someone invests in equity & makes money. They tend to think that they have a grip on the market & put in increasing amounts of money, only to get a rude jolt in the future.

Apart from this, people also indulge in some money maximizing tactics and invest aggressively, without considering their risk profile.  They decide for instance that they are through with the middle-class routine of investing in Mutual Funds & now want to invest in PMS, Structured Products, Alternate Investment Funds ( AIF), Private Equity, etc.  Most people don’t understand the risk-reward inherent in their investments & simply invest based on returns it has given in the past. This adds tremendous risks in the portfolio & is an example of unnecessary risk assumption.

Again, when things are going well, the heavens seem to be smiling and one is well set to achieve the goals, people feel that urge to stretch things a bit.  They want to achieve certain stretch goals, now that the going is fine.  This is a voluntary risk assumption. A high-end car, grand home in a tony neighborhood, world tours, lifestyle upgrade, etc. are some of those.  Nothing wrong in that for they are earning to enjoy.

But some of these increase the overall risks quite significantly. For instance, an expensive home bought on loan increases costs significantly & reduces headroom for maneuver. If the loan is so high that the couple needs to work for a long time, they lose the flexibility. Also, today there is the possibility of a job loss for any number of reasons.

Then, there is this goal of educating kids abroad, which is pretty common these days. The only issue is that this is by far the costliest exercise a parent can undertake. Children’s education is moreover an emotive issue & parents want to fund the whole binge, costing crores.

These things individually may not upset the overall life trajectory. But a few of these together can exert tremendous financial stress.

Health – When people are on medication and things start looking up, people loosen up a bit & start going freely on starches & fats! The effect of this is not immediately evident. But, it does have an impact with a lag. This is the same effect as when a person wears a helmet, he rides more rashly than he used to. Again an example of Risk compensation.

Conclusion –  Hence, when the risk reduces in the natural course or is perceived to reduce, we get into the mode of assuming more risks.

When risks are high but we take risk mitigation steps, the reduced risk again impels us to take on more risks, which is risk compensation.

At certain points in life, the risks reduce & things may be going smoothly. For some people the decreased risk makes them take up more risk, which is an example of Risk assumption.

Many times they perceive less risk than there really is. This is risk misperception due to which we end up taking unwanted risks.

This happens quite naturally in many facets of life. It is for us to recognize & avoid taking unwanted risks. Managing risks well is a fundamental part of wellness – whether it is money, health, work or other areas.

Let us pay a little more attention to risk – or we risk losing our sleep!

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