A risk-averse investor is an investor who is more conservative, focusing on preserving their capital instead of maximizing gains. A typical risk-averse investor would likely invest more heavily in low-volatility stocks instead of volatile growth stocks.
Investors generally follow the principle that risk is correlated with returns, and the greater the risk, the greater the potential returns. Risk- averse investors can still earn returns, but they prioritize capital preservation and lower-risk assets.
Let’s go over what it means to be risk averse, and evaluate a few potential investing strategies for the risk-averse investor.
Definition and Examples of Risk-Averse Investing
Risk-averse investing is investing that prioritizes asset preservation over earning returns. Investors are less willing to lose some or all of their investment in exchange for the potential for greater returns.
When analyzing an investment, risk-averse investors carefully consider potential downsides. For example, if they were considering a stock or bond, they might evaluate what would happen if the business went bankrupt or the company’s product failed, and the likelihood of that occurring.
Risk-averse investors tend to allocate more of their portfolio holdings to lower-risk assets such as blue-chip stocks or bonds and less to what are viewed as riskier assets with higher volatility, such as cryptocurrency or growth stocks.
For example, investors who are close to or in retirement tend to be more risk averse than younger investors because they usually depend on their investments to provide retirement income. So an investor approaching retirement may reallocate their funds from more aggressive assets such as stocks into more conservative assets such as bonds.
A younger investor, on the other hand, may be less risk averse because they have a longer time horizon for investing, which allows them more time to potentially recoup losses and secure greater gains in times of volatility.
How Risk-Averse Investing Works
Risk-averse investors who want to preserve their investment should consider the pros and cons of various investing strategies.
For example, those who want to have a near guarantee that they won’t incur losses might put their funds in a savings account or certificate of deposit (CD). However, those options generally offer lower returns than other assets can provide. In addition, their growth may not keep up with inflation trends, meaning an investor would actually lose earning power with these strategies.
Let’s review common investing strategies that a risk-averse investor might pursue.
Income investing is when investors aim to invest in a way that provides regular, reliable income with low-risk assets. They might, for example, hold bonds that will preserve their capital over the long term while paying regular interest payments, or fixed income.
Bonds can have varying degrees of risk, but they are typically considered lower risk than stocks because they are less sensitive to economic risks or geopolitical turmoil.
Government and municipal bonds are considered a safe type of fixed income asset because governments have the right to increase taxes to make payments, if necessary. Generally, the interest on these bonds is also tax exempt.
Investors using a fixed-income approach should be mindful of inflation risk, or the risk that the rate of inflation could outpace the fixed amount of income, so the investor would lose purchasing power.
Value investors aim to buy stocks that are undervalued, meaning they’re trading for lower prices than the company’s intrinsic value, or what it could really be worth. The idea is that the prices of these stocks will increase over time as investors recognize their true value.
Value stocks are generally considered lower risk than the broader market, but investors should keep in mind that it may take time for the stock to turn around, and they may have a greater risk of price fluctuations than growth stocks. So, this strategy is better suited for longer-term investors.
Investors who diversify their portfolios with a mix of assets lower their risk. You can improve diversity by investing in different types of assets, such as stocks, bonds, and real estate. You can also add diversity by varying the size of companies or industries in which you invest.
The idea is that if one asset suffers, your other assets can help offset your losses. Essentially, when you diversify, you avoid putting all your money into one asset, so you lower the risk of overall losses.
What It Means for Individual Investors
A risk-averse investor may use any one of a number of different investing strategies, but their main goal will be to minimize losses and preserve their capital, as opposed to making significant gains.
Keep in mind that there is no one perfect strategy for all risk-averse investors, because they will each have different financial situations and different investing goals.
- Risk-averse investors focus on preserving their capital, so they are less willing to take risks for the potential of more significant gains.
- Investors who are risk averse may favor fixed-income assets such as bonds or stocks with lower volatility, among others.
- Diversification helps investors reduce risk because it improves your chances that you won’t lose money.