Risk aversion

Having mentioned risk aversion in a recent text, this post goes back to explain this basic concept in the field of investing, which is also important in more than one way to your involvement in FinTech, we address here risk aversion. This concept, also as a comparable trait, derives from two finance axioms: any investment implies risk, and the intrinsic relationship between risk and return.

Investing means accepting risk

Starting with the riskiness investing, the fact is you can’t reach zero risk in a portfolio even if you try. As safe as you might consider your investments, something can always go wrong and you may lose at least a part of your allocated capital.

Since in Germany property seems to be perceived as a very low-risk investment, think of an uninsurable disaster, or an unforeseen structural problem significantly reducing the property’s value. Even leaving these extreme cases aside, all that needs to happen for you to loose money is simply a halt in price increases while inflation eats value out of your house or flat.

Also if you think that keeping cash is safest – either as a bank deposit or actual bills – don’t forget to consider at least the cost of inflation, plus risks such as that of loosing, having the money stolen or damaged, bank going bankrupt and so on.

Relating risk and return

So, accepting that investment carries risk, how does the risk relate to the returns I expect to receive? The theory says, risk and return come hand in hand. This means that the riskier your venture, the more should be its reward. This apparently simple rule helps explain why returns on one investment might be higher than another – expect it to carry more risk – while it can also justify why some investments simply make no financial sense. Any investment that does not compensate the investor for the risk they offer will have a hard time finding continuous interested investors.

Risk aversion on your case?

Now that we have described that all investments carry risk, and how returns are related to risk, let us connect that with the post’s topic: risk aversion. When comparing an investor who accepts more risk in their portfolio than another, the attribute of risk aversion comes in handy. The more risk averse is the one less likely to pursue higher returns by assuming more risk, will rather prefer security. Less risk aversion means, reversely, that the investor will pursue higher returns knowing that this means risking more. Again, avoiding risk completely is impossible, as well as taking an extreme amount of risk is also subject to interpretation, hence our use of comparative terms. We take the challenge to put this in numbers in a future post to illustrate and further the point.

Moving on to the financial world around us, some people mix their actual lack of interest in better managing their finances with an alleged higher perception of risk (or risk aversion). This is in my opinion an expensive mistake, since for me taking better care of your finances means you better understand the risks you are taking, so if you don’t want to think about it, it generally means you don’t know where your risks are.

Over the years, an interested investor gets more and more familiar with how risk actually works for their investments. In this sense, you start connecting the real-life causes which impact each of your portfolio’s segments, looking at risk more realistically and refining your perception of risk, hopefully making you (as it does to me) want to invest ever more and ever better.

Making use of this for your portfolio

Considering these concepts to draw a conclusion and recommendation, consider you can manage your total portfolio as conservatively as you prefer while allocating small amounts to experiment and learn with more risky (and better remunerated) investments. If you are looking at options of where to start, read more on this blog about FinTech investments. Alternatively, check out advocates of your financial product of choice, such as the specialist on Stock exchange investments and enthusiast of women’s strength as investors Sabine Roeltgen, as they can help you get better prepared to face the markets.

Whatever you do next – based on how ready you are to move forward in your financial management – don’t forget that your financial profile evolves over time. In this sense, don’t consider your current risk aversion as set in stone, as it can change a lot depending on the stage of your life and your financial situation. Talk to people you trust about this if you get the chance, you may find that someone you know and respect is much more versed in finance and investment with accompanying risks than you expect.