Risk Aversion vs Risk Tolerance: Choosing the right investment strategy for you
One of the biggest mistakes you can make as an investor is signing up for a financial product without understanding your own risk aversion and risk tolerance. Most negative feelings surrounding investment come from unexpected gains and losses from an investment that was not well researched. We’re going to talk about some of the risk factors of investment and how to assess if they are too much for you.
Imagine logging on to your investment account to find that you’re hundreds of thousands of dollars in debt. Unfortunately, this happened to one college kid trading on Robinhood when he tried trading on margin without fully understanding the risks.
Stock trading apps like Robinhood and eToro have gained huge popularity among new investors, but that doesn’t mean they’re always safe to use.
Aimed at young people, the apps give beginners access to sophisticated trading tools and claim to simplify the investing process — but many customers don’t realize or understand the risks involved.
Before investing you need to understand risk aversion or risk tolerance and choose investment products that reflect your personal preferences. We’re going to show you how that’s done.
What are investor risk aversion and risk tolerance?
Risk tolerance describes how much change you’re willing to accept in your investment returns. The more tolerant of risk you are, the less it concerns you if your investment value takes a sudden dive.
Risk aversion refers to an unwillingness for variation in returns. Risk-averse investors would prefer to know their money remains relatively stable over time while it’s invested.
Let’s put these terms into context.
Options for risk-averse investors
If you are risk-averse it’s important to remember investing will always involve some degree of risk. The whole point of investing your money instead of leaving it under your mattress is that you are entrusting someone else to create value from it
As a risk-averse investor, you may be interested in putting the majority of your funds in things like a high-yield savings account, CDs, or government bonds. However, these days the returns may fail to beat inflation.
You can also reduce risk by investing over a shorter period. Short-term investments that let you cash out quickly are a good way to test the waters of an investment type before going long.
Another way to reduce risk is through diversification. Investing in a single stock, cryptocurrency, or asset class exposes you to greater risk than having hundreds of different investments. The more investments you have, the less it impacts you if one fails.
Options for risk-tolerant investors
When kept within reason, investors benefit greatly from a little risk tolerance. Risk tolerance has a wide range of levels and tends to vary based on the percentage of savings invested. You’re much more likely to feel okay with a risky investment with a 5% chunk of your savings than 50%.
A risk-tolerant investor would want to put their assets into a range of more volatile assets with a higher potential for return. For example stocks, cryptos, business ventures, etc.
How to measure the risk of an investment
You can see past returns
Whether you’re investing in a fund, stock, or other type of asset, you should be able to find out core financial data about it. Although past returns don’t guarantee future success, they can give you a rough idea of how volatile an asset is.
If an asset value dipped 10% one month then gained 30% the next month, it’s safe to say that it’s volatile. But, if it gains or loses very little each month, it’s better suited to those with a stronger risk aversion.
It has good security
Another good indicator is checking what security measures the firm has in place. Is it regulated? Does it use other ways to protect your money, such as collateral?
You can also assess risk by assessing your own understanding. Could you explain what you’re doing to a five-year-old? Or does the platform lure you into a false sense of security, making the investment process feel like a game?
An option for risk-averse investors that still gets rates of 7%
At MyConstant, we want you to sleep well at night. That’s why we offer products that limit risk as much as possible while maximizing profit. And we outline everything about our service to you in detail on our blog.
For the least risk-tolerant investors, our collateral-backed account offers an annual return of 4% with minimal risk. You’ll lend out your money to borrowers who could default, but we reduce the risk involved by making borrowers put down 200% collateral.
You can even withdraw your money at any point.
If you’re a slightly more risk-seeking investor could try our Crypto Lend feature, which gives you an annual return of 9%. This product is riskier since you’ll also be lending to decentralized exchanges outside of the platform, but we take care to vet the third parties and keep your money safe.
Like the sound of either option? Create your free account today.
Share this article