What is Risk Averse And How To Measure Risk Averse?
When you invest, you need to decide what amount of risk you are willing to take for the potential of higher returns. A risk-averse investor is one who prefers lower returns with known risks over higher returns with unknown risks. A risk-averse investor has a conservative approach toward investment. They prefer to invest in government bonds, index funds, and debentures. In simple words, they give priority to avoiding loss rather than making gain.
If you are new to investing and are not ready to take risks in investing your money, here’s a list of investments you can choose and how to calculate how risk-averse you are, to make better investment decisions.
What is Risk Averse?
A risk averse investor preserves their capital by investing in lower-risk investments. The idea is to compromise with returns for a stable investment. A risk-averse investor avoids risky or volatile investments but has the potential for higher returns.
The volatility of a particular opportunity is called risk in investment. A stock whose value rises very quickly is considered more volatile than a stock whose value increases slowly over time.
Who are Risk Averse Investors?
Investors who choose more conservative investments to avoid risks are called risk-averse investors. These investors generally skip high-risk investment opportunities to choose safer, more stable returns. A risk-neutral investor is the opposite of a risk-averse investor.
This person evaluates an investment based on potential gains and avoids risks. People are usually more risk averse during their retirement when the source of income is limited, and they prefer to avoid losing money they might need at that stage of their life.
List of Investments that Risk Averse Investors Choose
Risk Averse investors choose investments with less volatility and higher stability. Here’s a list of investments risk-averse investors may choose:
- Savings Account
A savings account is an account that offers a fixed interest rate and is a secure method of storing funds. Banks, unions, or organizations that store people’s money offer a savings account. They provide a nominal rate of return to their investors in exchange for storing their money with them.
- Corporate Bonds
A corporate bond is a bond issued by a company in order to expand its business. It is more like debt or obligation. An investor who buys a corporate bond lends money to the company in return for a series of payments. This is a long-term investment and takes at least a year to mature.
- Municipal Bonds
A state or government issues a municipal bond. It is a debt security that is sold to an investor. The funds collected through this bond are used for public projects like road and bridge construction, education, and healthcare initiatives.
List of High-Risk Investments
Here’s a list of high-risk investments that risk averse investors avoid:
- Cryptoassets
- Real estate-based securities
- Crowdfunding
- Mini-bonds
- Foreign exchange
- Private company investments
- Inverse and leveraged ETFs
Also Read: 5 Ways To Diversify Your Investment Portfolio in 2022
How to Measure Risk Aversion?
Risk aversion is measured in terms of volatility. Risk aversion may change over time, and the investment options of an investor may vary based on their financial growth and ability to take risks.
The steps to measure risk aversion are as follows:
1. Absolute risk aversion
The arrow Pratt method of measuring risk aversion is a formula that generates a curve. The higher the curve is, the more risk the investor is willing to take. The formula is,
A(c) = -u”(c)/u'(c)
2. Relative risk aversion
This also measures the amount of risk an investor is willing to take. It uses a different formula.
R(c) = cA© = -cu”(c)/u'(c)
3. Portfolio theory
It measures the standard deviation of the return on investment. It calculates the potential expected reward an investor needs to accept risks.
Also Read: Alternative Investment Funds: Meaning, Features, Benefits & Tax
Final Word
Investing could help earn decent profits. However, risk aversion could reduce the profit margin but a low profit is assured. If you are new to investing, being risk-averse could help you gradually learn the ropes of various funds. You may start taking higher risks as and when you start becoming comfortable with investing. However, if you are closer to retirement, it is best to go for low-risk investments. To get started, visit Navi Mutual Fund now!
*Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
FAQs on Risk Averse
Ans: In economics and finance, risk aversion describes investors who prefer the preservation of capital over the potential for higher returns. In other words, they prefer certainty over uncertainty. A risk-averse person assumes that barring an unpredictable economic swing will cause a safe and secure investment that will generate reasonable returns.
Ans: Risk-averse people choose investment options which are more stable and less volatile. An investor is risk-averse if they decide to put their money in a savings bank account, with a lower but guaranteed return, rather than investing in the stock market, which is more volatile but gives high returns.
Ans: A risk-averse person will assess the volatility of their investment and will choose the ones that will lower volatility, even if it generates lower returns. Risk is equated with volatility in investment. The more volatile an investment is, the riskier it is. It has the potential of very high returns but also for very high loss. This is why risk-averse people choose low-volatile investments and compromise with their gains. They choose options that guarantee a sure-shot return.
Ans: If you are a risk-averse investor, you don’t like to take risks and play the gamble but prefer secure investments that guarantee some nominal returns. It is essential in investment as this behaviour can deprive you of your ability to take risks and generate very high returns.
Ans: A risk-averse person evaluates the investments’ volatility and chooses the less volatile ones. Certain investments have shown stability and slow growth. That means it is improbable for them to drop drastically in value.
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Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
