Risk Aversion

Risk Aversion: Guarding Your Finances
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Risk aversion is a manifestation of people's general preference for certainty over uncertainty, and for minimizing the magnitude of the worst possible outcomes to which they are exposed.

How Do Risk-Averse People Behave?

Thus, a risk-averse person may prefer being a low-paid employee with apparent job security over being a self-employed entrepreneur with the opportunity to earn a large sum of money, if that opportunity also comes with the risk of losing one's investment in time and/or money.

Likewise, a risk-averse person will prefer a low but sure rate of return, such as on a bank account, over a much higher potential rate of return on equities, since the latter is highly variable and can be negative.

Many risk-averse people make choices by putting excessive weight on the worst possible outcomes, far beyond the actual probabilities that they will occur.

What Influences Risk Aversion?

Risk aversion is highly influenced by experience, especially the economic environment during childhood. People who grew up in different economic climates tend to manage money very differently.

The classic example is people who grew up during the Great Depression of the 1930s. As a group, these people tend to be very conservative about money and very risk-averse about job or career changes. Many of them avoid stocks, given memories of the Great Crash of 1929.

However, many spendthrifts grew up during the Great Depression.

Likewise, many sets of siblings develop radically different attitudes about money.

Financial advisors, financial planners or insurance sales agents ar example of financial professionals who must understand clients as well as they can, to serve them best. With respect to risk aversion, just understanding the time and place in which they were born can offer useful (though hardly infallible) insights.

Also Known As: risk avoidance

Examples: John's risk aversion caused him to prefer remaining a staff accountant at XYZ Corp. rather than opening up his own accounting firm.

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