A better risk calculator could help retail investors make better investment decisions, argues a new white paper from an economist at the U.S. Securities and Exchange Commission (SEC).
The White Paper on Computing Tools for Promoting Sound Investment Decisions, which does not reflect SEC policy, proposes a new risk calculator that the author believes could improve investment decision-making. “Numerous academic studies document that retail investors make systematic ‘mistakes’ in assessing the risk and return characteristics of their portfolios,” it says. And so, the paper, authored by SEC economist Jeremy Ko, proposes a tool that aims to help individual investors better assess these characteristics by displaying simulated portfolio returns.
The paper notes that while a number of free online investment calculators already exist. “None of these calculators characterize risk other than possibly at a single point in the distribution,” it says. The calculator proposed in the paper aims to characterize the risk of a portfolio at multiple points, thereby providing “more information to the user about the probabilities of different outcomes. The individual can potentially make more informed decisions based on this larger set of information.”
The proposed tool allows investors to determine the distribution of returns for different portfolios. “Investors can then choose among these portfolios to optimize their exposure to risk and return. Otherwise, retail investors may have to rely on faulty judgments,” it says.
By allowing investors to freely choose their optimal portfolio, the paper also notes that the calculator, “has the advantage of not making any problematic or implicit assumptions about risk aversion.”
It hopes that various organizations may provide the calculator online to help investors. “A principal goal of this project is to encourage hosting this proposed tool online by organizations such as not-for-profits, self-regulatory organizations, financial media outlets, and retirement plan fiduciaries,” it notes.