How can you best communicate what investment risk means to you?

Some critical aspects of finance are hugely subjective, which raises the question of how best to avoid ambiguity and the chance of misunderstanding when communicating with others about them

03/04/2019
iStock-jenga-blocks_EPI

Authors

Andrew Evans
Fund Manager, Equity Value

The worlds of investment and finance in general are often criticised – and justifiably so – for being overly fond of jargon.

Arguably of even greater risk to investors, however, are words and phrases that, on the face of it, appear straightforward but can mean markedly different things to different people.

‘Value for money’ would be a good example – as would a word we have already used in this piece: ‘risk’.

These are tricky concepts for everybody involved in investment and finance – consumers, providers, advisers, the media, the regulators – because they are so subjective.

Nobody can definitively state: “This option represents good value for money for you.” Nobody can definitively state: “This option represents too much risk for you.”

Focusing in on risk as an example, here on The Value Perspective, we would argue the erosive nature of inflation makes it risky to hold too much cash (note the way we have given ourselves wiggle room by using another subjective phrase ‘too much’).

And yet, even at a time of historically low interest rates, millions more Brits still prefer to put billions more pounds into cash Isas than they do into the stocks and shares variety.

The military isn't immune either 

The dangers inherent in communicating the ideas of risk and uncertainty are by no means confined to investment, however.

Take the rather more life-or-death world of military intelligence – in his study Psychology of Intelligence Analysis, for example, Richard Heuer highlights an experiment where analysts were asked to put a numerical probability on a line of a report they had prepared earlier.

The line was the simple enough “The cease-fire is holding but could be broken within a week” yet, while one analyst said he had meant there was a 30% chance the cease-fire would be broken within a week, his colleague said she had meant there was an 80% chance of this happening. “Yet when working together on the report,” writes Heuer, “both analysts had believed they were in agreement about what could happen.”

Heuer also references a wider experiment where 23 NATO officers accustomed to reading intelligence reports were given a number of sentences where the only difference was the wording at the start, which ranged from “Almost certainly …” all the way down to “Chances are slight …”.

Again they were asked to attribute numerical probabilities to each sentence – and again there was a wide disparity of interpretation.

As Heuer notes, “an intelligence report may have no impact on the reader if it is couched in such ambiguous language the reader can easily interpret it as consistent with his or her own preconceptions”.

Incidentally, you can read a quirkier view of how different professions view probability – from weather forecaster and political journalist to ‘Mission Impossible Agent’ (“What would that even mean?”) at Maths with Bad Drawings.

The site’s creator has yet to come up with an illustration of how a value investor sees risk – presumably because it would be nowhere near as amusing as that of ‘Millennium Falcon captain’ on ‘probability of successfully navigating an asteroid field’ (“Never tell me the odds”) – so it seems appropriate to finish with a quick observation of how we communicate risk to each other, here on The Value Perspective.

Don't leave language up for interpretation

As we have written in articles such as Four investment edges, an integral part of our investment process is to balance our assessment of the associated risks of buying into a business with the potential rewards.

Naturally this means we have to find a suitable way to convey our perceptions of risk to other members of the team and, as we have seen, the subject matter involved means using language leaves things open to misinterpretation.

Instead, our answer is to use a numerical scale.

It is not a perfect solution, we admit – but then, in matters of subjectivity, nothing short of telepathy will be.

And, appropriately enough, we have found using numbers to describe risk does reduce the risk of misunderstandings.

Subscribe to our Insights

Visit our preference centre, where you can choose which Schroders Insights you would like to receive.

Authors

Andrew Evans
Fund Manager, Equity Value

Topics

The Value Perspective
Follow us

Please remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

This marketing material is for professional clients or advisers only. This site is not suitable for retail clients.

Issued by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registered Number 4191730 England.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.

Schroder Unit Trusts Limited is an authorised corporate director, authorised unit trust manager and an ISA plan manager, and is authorised and regulated by the Financial Conduct Authority.

On 17 September 2018 our remaining dual priced funds converted to single pricing and a list of the funds affected can be found in our Changes to Funds. To view historic dual prices from the launch date to 14 September 2018 click on Historic prices.