Price volatility influences investment risk. A volatile investment may either make you richer or devour you of all your savings. Whereas conservative investment grows slowly, guaranteeing good returns in the long run. This is what risk aversion means. Risk-averse describes an investor who chooses to preserve capital over the potential for higher investment return.
A low-risk investment guarantees reasonable and unspectacular returns. Additionally, it assures zero loss of original investments. Returns on low-risk investment slightly exceed inflation, whereas high-risk investment reaps a bundle of money.
Risk-averse signifies an investor’s reluctance to take on risks. All types of investment carry a level of inherent risk, and a risk-averse investor is averse to uncertain risks involved in investment.
Investments on fixed deposits, fixed income statements, and certificate deposits, are kinds of investments that yield fixed returns with marginal or zero risk. Risk-averse investors prefer considering such assets in their portfolio to investing in high-risk investments.
Types of Risk Investors
Risk-neutral is an investor’s attitude that evaluates and analyses alternatives, focusing on potential gains, regardless of the risks involved. This type of investor only craves potential gains, ignoring the potential downside of investment. Such investors neither prefer taking high risk nor do they favour lower-risk investments. They take calculated risks as they do not want to bear profound losses.
Risk-averse investor opts to avoid potential risk and aims to choose the lower-return investment that yields slower returns. These investors avoid as much risk as they can and prefer low-profile portfolios.
Risk lovers are investors who love to play big. They consider investments gambling, where they might devour huge losses or take up bundles of money. Risk lover investors get fascinated with lucrative high rates of returns on investment.
What Makes an Investor Risk-Averse?
Investors’ risk tolerance plays an important role in creating a financial portfolio. It also determines the investor’s approach and willingness to invest. Investors are risk-averse because of low-risk tolerance that usually depends on an individual’s personal and business circumstances.
Usually, the factor affecting risk tolerance and aversion to risk is an individual’s experience in fiscal market operation. Economic collapses in the 2008 Global Financial Crisis and Great Depression are a few factors behind resilience to risk. Many investors have learned from such situations and are now focusing on capital preserving rather than running after high-return investments.
Types of Securities in Risk-Averse Investor’s Portfolio
Risk-averse investments found in a risk-averse investor’s portfolio are;
Most risk-averse investors choose to open high-interest accounts or certificate deposit accounts. These deposits guarantee stable returns and are not subject to market fluctuations.
Out of all the debt securities, government bonds are ranked as high-return investments. Risk-averse investors or risk intolerants choose to invest in government bonds for their coupon payments and face value returns on maturity.
The stock market is highly volatile, but some shares produce assured returns despite market fluctuations. Investors allocate blue chips to their portfolios as the underlying companies offer dividend-paying stocks. They may also invest in preferred shares that give priority share dividends to their shareholders.
Examples of low-risk funds include mutual funds, index funds, exchange-traded funds, or investments in listed companies that assure stable returns over a long time. Investors who do not prefer investing in shares may choose to invest in low-cost funds to get reasonable returns without any risk involved.
Advantages of Risk Aversion
A risk-averse investor invests his money in assets that do not bear any losses and guarantees potential income. Such investors get attracted by companies that have offered guaranteed income for a long time and have proved themselves time-tested. Therefore, their capital loss is minimal or negligible compared to a risk-lover investor.
Risk-averse investors generate fixed income on investment because of the profile they choose. They invest in mutual funds, shares, certificate deposits, and bonds that hardly fluctuate with market conditions. Hence there is little or no risk involved for risk-averse investors.
Usually, retired people, senior-aged investors, or people who have experienced great depreciation are risk-averse investors. They intend to invest in portfolios that generate steady income as they cannot afford potential capital losses. Low-risk investments offer steady income and a peaceful night’s sleep to the individual.
Disadvantages of Risk Aversion
Risk aversion is an investor’s tendency to avoid high risk and invest in low-return investments. However, investors unknowingly lose high growth opportunities and credibility in the financial market. It is always better to diversify one’s portfolio and seek expert advice if needed.
An investor's appetite depends on his risk tolerance, age, experience, and capacity to bear fluctuating losses. Although risk aversion is advantageous, people looking for high-growth opportunities must invest in high-risk investments.