Risk Averse Investors: Higher Amounts, Safer Bets

Risk-averse investors tend to avoid volatility and high-risk investment opportunities in favour of safer, more conservative investments. They are willing to sacrifice higher returns for capital preservation and a more stable, slow-growth approach. This means that risk-averse investors are more likely to invest higher amounts, as they are prioritising the safety of their principal over the possibility of higher returns on their money.

Low-risk investments

High-yield savings accounts

High-yield savings accounts are a great option for those seeking a modest return on their money. These accounts are government-insured, meaning you'll be compensated even if the financial institution fails. While the returns may not be spectacular, they generally match or slightly exceed the level of inflation over time.

Money market funds

Money market funds are mutual funds that invest in short-term, low-risk assets like treasury and government securities, commercial paper, or municipal debt. They offer diversification and liquidity, and typically pay out cash interest on a regular schedule. While the income received can fluctuate based on the yields of the underlying securities, these funds are generally pretty safe.

Short-term certificates of deposit (CDs)

CDs are a great option for those seeking a fixed interest rate over a set period, typically ranging from 6 months to 5 years. CDs are FDIC-backed, meaning your money is safe unless you withdraw it early. Short-term CDs offer better liquidity than longer-term options and currently offer attractive rates.

Cash management accounts

Cash management accounts are a feature offered by many brokerages, combining the functions of a checking and savings account. These accounts often offer competitive interest rates and allow easy access to funds, making them a good option for those seeking both stability and liquidity.

Treasurys and TIPS

Treasurys, including Treasury bills, notes, and bonds, are highly liquid securities backed by the US government. Treasury bills mature in one year or less, notes stretch up to 10 years, and bonds mature in up to 30 years. Treasury Inflation-Protected Securities (TIPS) are a type of security that adjusts with inflation, providing a hedge against inflation.

Dividend-paying stocks

While stocks are generally riskier than the previously mentioned options, dividend-paying stocks are considered safer than high-growth stocks. These stocks tend to be from more stable and mature companies, and they offer regular dividend payments, helping to limit their volatility.

Money market accounts

Money market accounts are similar to savings accounts but may require a higher minimum deposit. They often offer higher interest rates than savings accounts and provide a debit card for easy access to funds. Like savings accounts, they are FDIC-insured, making them a safe option for those seeking stability.

Deferred fixed annuity

A deferred fixed annuity is a type of annuity issued by insurance companies, providing a guaranteed rate of return over a set period. This option allows your investment to grow tax-deferred and offers a guaranteed income, making it attractive for those seeking financial security, especially during retirement.

Investment-grade corporate bonds

Investment-grade corporate bonds are considered low to moderate risk, depending on the bond. They are highly rated, indicating a lower default risk, and offer moderate returns. However, bond prices are sensitive to interest rate changes, and there is a risk of default if the issuing company faces financial troubles.

Municipal bonds

Municipal bonds are funded by tax collections or other government revenues and are considered low to moderate risk. They offer tax-free income, making them attractive to investors in higher tax brackets. However, they have a less active secondary market, making them somewhat illiquid.

Remember, while low-risk investments provide stability and help protect your capital, they also typically result in lower returns over the long run. It's important to consider your financial goals, risk tolerance, and investment horizon when deciding where to allocate your money.

Risk-averse investors' preferences

Risk-averse investors tend to focus on capital preservation and stable, predictable returns, rather than maximising gains. They are generally less comfortable with volatile investments and have a low tolerance for risk.

Risk-averse investors tend to favour low-risk investments such as:

• Savings accounts
• Certificates of deposit (CDs)
• Money market accounts
• Certain bonds
• Dividend growth stocks
• Permanent life insurance
• Index funds
• Debentures
• Fixed-income assets
• Blue-chip stocks
• Government bonds
• Fixed-interest accounts
• Term deposits
• Cash
• Investments in property trusts

Risk-averse investors tend to avoid high-risk assets such as small-cap equities, derivative products, or cryptocurrencies.

Risk-averse investors also tend to favour diversification in their portfolios, investing in a variety of assets and asset classes to reduce the risk of losses.

Risk-averse vs risk-neutral

Risk-averse investors tend to focus on capital preservation rather than capital appreciation. They favour certainty over risk, opting for stable and slow-growth investments with predictable outcomes. Risk-averse investors tend to choose lower-risk investments such as cash equivalents, fixed income, and high-quality debt instruments. They also tend to prefer liquid investments, meaning their money can be accessed when needed, regardless of market conditions.

Risk-neutral investors, on the other hand, focus solely on potential gains when evaluating investment opportunities, ignoring the potential downside risk. They are indifferent to risk and are not driven by fear of losing money or eagerness to make money. This mindset is often situational and can depend on external factors such as price. Risk-neutral investors are willing to take on more risk to achieve higher returns.

While risk-averse investors tend to avoid volatile investments, risk-neutral investors are willing to accept volatility in their investment portfolios. Risk-averse investors are typically found among older investors and retirees who are unwilling to risk their savings, whereas risk-neutral investors are more concerned with the potential for gains and are less averse to potential losses.

Risk-averse investors may miss out on potential opportunities for higher returns, as they tend to favour lower-risk, lower-return investments. In contrast, risk-neutral investors are willing to take on more risk in pursuit of higher returns, but this also increases the potential for losses.

In summary, risk-averse investors prioritise capital preservation and stable, predictable returns, while risk-neutral investors focus solely on potential gains, ignoring the associated risks.

Risk-averse investment strategies

Risk-averse investors tend to focus on capital preservation and slow, stable growth, rather than taking risks for potentially higher returns. This means that risk-averse investment strategies tend to involve lower-risk asset classes such as cash equivalents and fixed-income securities.

• Income investing: This strategy involves holding a portfolio of fixed-income securities, such as bonds, that generate stable and regular cash distributions. It is a popular strategy for those who are retired or approaching retirement due to its low risk and opportunity to generate income.
• Holding a well-diversified portfolio: This strategy involves holding a diverse mix of assets that are less correlated with one another, meaning they are expected to perform differently in specific market conditions. By doing this, investors can optimise the risk and reward of their portfolio over the long term.
• Investing in low-risk products: Risk-averse investors tend to favour low-risk investments such as certificates of deposit, high-quality debt instruments (e.g. investment-grade corporate bonds), government bonds, and treasury bills. These types of investments offer guaranteed cash flows and constant positive returns over time.
• Mutual funds or Exchange-Traded Funds (ETFs): ETFs, especially those invested in market indexes, are considered a relatively safe investment option for risk-averse investors as they tend to experience lower volatility due to their diversified nature.
• Dollar-cost averaging: This strategy involves making predetermined contributions to your portfolio on a periodic basis, so you are consistently buying into the market regardless of short-term performance or events. This can help to smooth out general market risks.

While these strategies can help to minimise the chance of loss, it is important to remember that all investments carry some degree of risk. Risk-averse investors should also be aware of the potential opportunity cost of their investment strategies, as lower-risk investments tend to result in lower returns over time.

Pros and cons of risk aversion

Risk-averse investors tend to focus on capital preservation and stable, slow growth rather than higher-risk investments. This approach has its pros and cons.

Pros of risk aversion:

• Minimises risk of losses: Risk-averse investors tend to avoid high-risk businesses that are susceptible to severe market movements or downturns. By investing in assets such as bonds, savings accounts, or a diverse range of investment portfolios, they can reduce the risk of major financial losses due to market changes.
• Generates a steady income: Risk-averse investors value reliable returns over high-risk, high-reward investments. Low-risk investments like bonds, dividend-paying equities, or fixed-income assets offer predictable and regular income through interest payments, dividends, or coupon payments.
• Assured cash flows: Risk-averse investors choose low-risk investments because they can expect set and predictable returns. These assets usually have legal agreements attached to them, which provide consistent and predictable profit flows in the form of benefits.

Cons of risk aversion:

• Lower levels of expected returns: Conservative investments often yield lower returns compared to riskier, higher-yield assets. Risk-averse investors may miss out on potentially large rewards by avoiding high-growth or unpredictable markets.
• Possibility of missing great opportunities: By choosing to stay on the safe side, risk-averse investors may reject high-growth opportunities or creative initiatives that could provide significant rewards. This can lead to limited exposure to potentially profitable ventures and limit participation in growing markets or innovative businesses.
• Limited long-term growth: While stability is important, taking on too little risk may hinder the ability to reach retirement or long-term financial objectives. High-risk investments have a higher likelihood of success in the long run, despite the possibility of short-term failure.
• Inflation: Lower-risk investments may not always deliver returns above or in line with inflation, reducing purchasing power over time.

Frequently asked questions