Risk preference can be defined as the tendency to select less dangerous or risky options. Financial professionals and economists in investments generally apply the concept. However, it can also be used in any decision-making process, provided it involves risk. Risk preference is characterized into three categories, which are risk aversion, loving, and neutrality. Risk aversion involves reluctance to take on risk. Instead of taking chances on a possible failure, an individual decides to venture into safer investments (Suwarno & Mahadwartha, 2017). When risk aversion is applied, a guaranteed success has a higher probability than any other possible result.
Risk loving preference involves a willingness to take higher risks with the hopes of gaining above-normal returns. Before applying the choice, all the elements involved in the risk must be weighed to determine the probability of undesired outcomes. The step enables the decision-maker to choose between taking the risk or applying other measures. Risk neutrality falls between risk loving and aversion. An individual who uses risk neutrality has no care of any possible risk involved in making a decision (Suwarno & Mahadwartha, 2017). People who apply the risk neutrality preference choose assets with possibly higher returns without considering likely outcomes.
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Average investors do not spend a lot of time researching different investment opportunities. They also use simple devices such as the Morningstar ratings to make decisions concerning investments. Most average investors manage their portfolio since they prefer not to pay financial advisors because of the high charges. Given the above description of an average investor, risk aversion seems to be the best in the category. Since most average investors do not have much input, they would generally select a guaranteed payment because of the belief that getting something, however small, is better than nothing. However, the payout gained from an investment still needs to meet the investment returns demand.
Reference
Suwarno, A., & Mahadwartha, P. A. (2017). The analysis of portfolio risk management using VAR approach based on investor risk preference.
