What is Risk Averse?
Someone who is risk averse has the characteristic or trait of preferring avoiding loss over making a gain. This characteristic is usually attached to investors or market participants who prefer investments with lower returns and relatively known risks over investments with potentially higher returns but also with higher uncertainty and more risk. A common concept tied to risk, one which compares the risk level of an individual investment or portfolio to the overall risk level in the stock market, is the concept of beta.
Types of Investments Risk Averse Investors Choose
A risk averse investor tends to avoid relatively higher risk investments such as stocks, options, and futures. They prefer to stick with investments with guaranteed returns and lower-to-no risk. These investments include, for example, government bonds and Treasury bills. Below are two lists that classify lower and higher risk investments. Keep in mind that while the relative risk levels of various types of investments generally remain constant, there can be situations where a usually low-risk investment has a higher risk or vice versa.
Safer, low-risk investments
- Certificates of Deposit
- Treasury securities
- Life Insurance
- Investment Grade Corporate Bonds
- Bullet Loans
In addition to these specific investments, any type of debt instrument issued by a company will generally be considered a safe, low-risk investment. These debt instruments are typically well-suited for a risk averse investing strategy.
These instruments are lower risk at least partly due to their characteristic of absolute priority. In the event of dissolution or bankruptcy of a company, there is a definite order of payback to the company’s creditors and investors. Legally, the company must first pay off debtors before paying off preferred shareholders and common shareholders (equity investors).
Higher risk investments
- Penny Stocks
- Mutual Funds
- Financial Derivatives (Options, warrant, futures)
*Some ETFs come with a higher risk, but most ETFs, especially those invested in market indexes, are considered quite safe, especially when compared to investments in individual stocks. This is because they typically experience relatively lower volatility, due to their diversified nature. Keep in mind, however, that some ETFs are invested in significantly higher risk securities. Hence, the inclusion of ETFs in both the low- and high-risk categories.
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