Risk preference is your tendency to choose a risky or less risky option. Generally, economists and financial professionals apply the concept of risk preference to investors and economics, but you can also apply risk preference to any decision you make that involves risk. Several types of risk preference exist, and the associated risk involved generally depends on the decision maker and for whom the decision maker takes the risk.
Risk-Seeking Preference
A risk-seeking preference applies to a person willing to take higher risks to achieve above-average returns. The person making this type of decision should weigh all the factors involved in the risk and assess these risks against the probabilities of different outcomes. This allows the decision maker to determine if the risk is worth the chance. Sometimes a group of individuals will work together to evaluate the risks and form a consensus.
Risk-Averse Preference
A person who is reluctant to take on a risk has a risk aversion. This kind of personality almost always chooses the safer investment instead of taking a chance on the probability of failure. To someone with a risk-averse preference personality, the guarantee has more weight than any other possible outcome. Risk preference assessments of key decision makers in an organization can help the organization delegate the right authority to the right people and avoid potentially disastrous decisions.
Risk-Neutral Preference
An individual with risk-neutral preference does not care about the risks involved in the decision making. She is only concerned about the end result. A risk-neutral individual will choose the assets with the highest possible gains or returns without taking into account possible outcomes. These preferences apply not only to individuals, but also to investment firms that build reputations based on a risk preference strategy.
Investor Tolerance
Whether you personally invest your own money or you use an investment firm to invest your money for you, you should understand your risk tolerance. This tolerance has several variables. For example, time and money usually influence how much risk you will take. If you are a retiree, your risk preference generally becomes averse because you will not have time to make up for large losses. If you are in your late 20s, on the other hand, you may choose to take more chances with your assets, making your preference risk seeking.