What Is Risk-Seeking?
Risk-seeking is one's acceptance of greater risk, in finance often related to price volatility and uncertainty in investments or trading, in exchange for the potential for higher returns. Risk seekers are more interested in capital gains from speculative assets than capital preservation from lower-risk assets.
Risk-seeking can be contrasted with risk-averse.
Key Takeaways
- Risk-seeking refers to an individual who is willing to accept greater economic uncertainty in exchange for the potential of higher returns.
- Risk-seeking confers a high degree of risk tolerance, or the amount of potential losses an investor is willing to accept.
- In contrast with risk-seeking investors, risk-averse investors seek low-risk investments and are willing to accept a lower rate of return because of the desire to preserve capital.
- Examples of asset types that might attract a risk-seeking investor include options, futures, currencies, penny stocks, alternative investments, cryptocurrencies, and emerging market equities.
Understanding Risk-Seeking
Risk-seeking individuals leverage the trade-off between risk and return by accepting more risk in hopes of above-average returns. In general, higher-risk investments demand higher expected return potential, although the quality of the asset in question must be considered beforehand to ascertain whether there is sufficient return potential to justify the risk involved.
Some examples of types of assets that risk-seeking investors would be attracted to would be small-cap equities, derivatives, emerging market equities and debt, currencies of developing countries, junk bonds, and commodities, to name just a few.
Risk-seeking might also describe entrepreneurs who are willing to give up the stability of salaried employment at an established company to start their own companies in the hope of a greater financial and emotional payoff.
Special Considerations
Risk-seeking behavior tends to rise in bull markets, when investors, encouraged by gains in the financial markets, are coaxed into thinking that the good times will continue. There is always a subset of risk seekers who orient their strategies around high-risk/high-return investments. Others, however, may shed their discipline to chase momentum stocks, for example, or try their luck with a hot initial public offering (IPO) that they know little about.
Risk-seeking is an equal opportunity activity sought out by retail investors and professional fund managers alike, but it can go too far. Examples of when risk-seeking behavior caused many investors and speculators to lose huge sums of money include the dotcom bubble of the early 2000s and the housing bubble of the mid-2000s.
$17 trillion
The amount lost in U.S. household net wealth from 2007 to the first quarter of 2009 after the collapse of the housing bubble and onset of the global financial crisis.
Risk-Seeking vs. Risk-Averse
Risk tolerance is an important concept for investors and refers to the degree to which an investor is willing to accept risk for the potential of a higher return. Risk-averse investors opt for low-risk investments and are willing to accept a lower rate of return because of the desire to preserve capital.
Financial advisors endowed with common sense counsel their clients to minimize risk-seeking behavior with respect to their investments. In many cases, particularly for younger individuals, risk-seeking is part of an overall investment strategy, as risk assets can provide a boost to total portfolio returns.
For individuals who need more certainty of funds for an imminent house down payment, college education, or retirement, lower-volatility investments are recommended. Risk-averse investors would prefer to look to assets such as government securities, blue-chip dividend stocks, investment-grade corporate bonds, and even certificates of deposit (CDs).
High-Risk Portfolios
Risk-seeking investors will often construct a portfolio of high-risk investments that they believe have the potential to reap high gains. There are various strategies investors can employ to construct a high-risk portfolio.
One strategy is to create a concentrated portfolio focused only on investing in a single sector or industry, such as technology. This type of portfolio can work best for an investor who already possesses knowledge of the sector and understands it well.
Another strategy for a high-risk portfolio is momentum investing. This method relies upon working with volatility and seeking investments that are already trending up. The momentum investor is not looking for a long-term investment but instead wants to capture short-term gains and sell the investment as soon as momentum wanes. Several timing risks exist with this strategy, such as getting into a position too early or closing out too late to achieve the best gains.
Other strategies for building a high-risk portfolio include investing in currencies, options, or futures. Each of these asset types uses the power of leverage, which enables investors to multiply their buying power in the market. To be successful in these strategies requires investors to be well-educated in trade execution and research. Investors need to monitor these investments closely, be able to stomach fast-paced trading scenarios, and be able to develop an exit strategy to preserve capital and gains.
FAQs
Risk-seeking is one's acceptance of greater risk, in finance often related to price volatility and uncertainty in investments or trading, in exchange for the potential for higher returns. Risk seekers are more interested in capital gains from speculative assets than capital preservation from lower-risk assets.
What is the risk-seeking theory? ›
According to prospect theory, people are risk averse in the gain frame, preferring a sure gain to a speculative gamble, but are risk seeking in the loss frame, tending to choose a risky gamble rather than a sure loss (Kahneman and Tversky, 1979, 1984; Tversky and Kahneman, 1981).
What is an example of a risk seeker? ›
While most investors are considered risk averse, one could view casino-goers as risk-seeking. A common example to explain risk-seeking behaviour is; If offered two choices; either $50 as a sure thing, or a 50% chance each of either $100 or nothing, a risk-seeking person would prefer the gamble.
What is risk-seeking in project management? ›
Risk Seeker – enjoys and seeks uncertainty in search of greater opportunities, can be overly optimistic and not take possible negative consequences seriously. Risk Averse – uncomfortable with uncertainty, doesn't like risk.
What are the three components of a risk profile? ›
The three main components are risk capacity, risk tolerance, and risk requirement. It is a common technique used in financial markets where financial advisors use it to decide on investments and asset allocations associated with portfolios.
What is an example of prospect theory risk-seeking? ›
An example of prospect theory is when someone has the opportunity to win $100 but risks losing $50 if they do not take the risk. They would be more likely to take the risk because they desire a greater reward.
Is prospect theory risk-averse vs risk-seeking? ›
The interplay of overweighting of small probabilities and concavity-convexity of the value function leads to the so-called fourfold pattern of risk attitudes: risk-averse behavior when gains have moderate probabilities or losses have small probabilities; risk-seeking behavior when losses have moderate probabilities or ...
What are the benefits of being risk-seeking? ›
In conclusion, the benefits of risk-taking in youth development are numerous and significant. By encouraging young people to take risks, we can help them develop resilience, confidence, problem-solving skills, leadership skills, creativity, innovation, and the ability to manage fear.
What are the four examples of common risk responses? ›
Avoidance - eliminate the conditions that allow the risk to exist. Reduction/mitigation - minimize the probability of the risk occurring and/or the likelihood that it will occur. Sharing - transfer the risk. Acceptance - acknowledge the existence of the risk but take no action.
What is the difference between risk taker and risk seeker? ›
Risk-seeking is the pursuit of high gains, even at the cost of high risks. Risk-takers in financial markets prefer risky stock positions, eccentric investing, options trading, futures, cryptocurrencies, startups, and penny stocks. A risk-averse investor is a polar opposite.
A risk-loving person exhibits increasing marginal utility. That is, for every $1 increase in income, the increase in utility from that extra income is higher. For the risk-loving type, the chance of winning big versus losing it all is worth more than a certain outcome. Losses are not a concern to them.
What are the three categories of risk preference? ›
It is not possible in every case to unambiguously assign subjects to one of the three categories of risk preference (risk-averse, risk-neutral and risk-loving).
What is the full meaning of risk? ›
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environment), often focusing on negative, undesirable consequences.
What are the 3 C's of risk? ›
A connected risk approach aims to connect risk owners to their risks and promote organization-wide risk ownership by using integrated risk management (IRM) technology to enable improved Communication, Context, and Collaboration — remember these as the three C's of connected risk.
What are the risk profile considerations? ›
Risk Profile Considerations
Some questionnaire topics include age, major life changes, income, and investment comfort level. In addition to financial questions, a questionnaire may inquire about how you handle potential losses.
What are three 3 principles of risk management? ›
When it comes to risk management, there are three main principles that can help you achieve better results.
- Identify & Assess Risks Early. This might seem obvious but identifying the risks early on is vital. ...
- Create a Plan to Manage the Risk. ...
- Consider Goals and Objectives.
Risk avoidance: This approach asks if the risk should be avoided. For example, the production of a proposed product is canceled because the danger inherent in the manufacturing process creates a risk that outweighs potential profits.
What are examples of risk-averse people? ›
For example, a risk-averse investor might choose to put their money into a bank account with a low but guaranteed interest rate, rather than into a stock that may have high expected returns, but also involves a chance of losing value.
What is an example of risk avoidance in real life? ›
An example of risk avoidance might be a manufacturing business not using certain hazardous materials or chemicals due to the dangers of handling and storing them; or, an organization limiting the type of customer data it stores on its computers in case of a cyberattack.
What is a real life example of risk? ›
A driver is approaching a yellow light and must choose to brake in order to stop in time for the light to turn red or to accelerate to make it through the light before it turns red. If the driver accelerates, he is risking going through the light which could result in an accident or a ticket.
