What is the difference between ‘risk averse’ and ‘risk neutral’ in economics?

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What is the difference between ‘risk averse’ and ‘risk neutral’ in economics?

In society money is very important; Due to this, in the world of the economy if you are going to invest your capital, it is good that you are clear that there are types of investors. In this article we will explain the difference between risk averse and risk neutral. This way you will have an idea with which you identify.

Investor

First of all, what is an investor? Well, in reality it can be anyone who sets aside capital or money for a certain investment. Its purpose is, of course, a profit return.

When investing, they usually use several markets, because they seek to obtain profits from different investments. Of course, something you should keep in mind is that what you get will depend a lot on your risk tolerance.

risk-averse investor

They are those individuals who prefer a safe situation, although their profitability is minimal. The vast majority of people, due to their behavior when investing, end up fitting into this group. So he will look for a way to avoid, among his possibilities, taking risks for free. They even contemplate the option of earning money without the need to invest.

risk meter indicating the minimum level

For example, when presented with 2 investment opportunities with the same benefits, the risk-averse investor will generally have this behavior, when thinking about it, he will prefer the one that reports less risk. In short, you will always demand a higher return with a minimum of risk.

risk neutral

In this case, we are referring to a person who does not care about taking the risk or not taking it, as long as the expected value is the same. This indicates that at the moment of making decisions, when investing they do not consider the risk; but for them the most important are other parameters such as the rate of return (benefits) and market momentum. In this aspect, you will notice that financial experience is important.

user looking at market behavior

differences

To help you understand these terms, we are going to illustrate them for you. In this way we will be able to easily distinguish the differences between these 2 behaviors. We will present you 2 different scenarios. For example:

  • The risk averse. In a game center you are not going to invest in a game whose expectation is equal to 0 or negative. Sure, no one wants to play to lose. But in addition, they tend to discard, not always, games that give them a positive possibility. Why? Here we can identify the difference. Because they have the mindset to avoid the risk of losing what they already have. So, if they don’t play at least they will keep what they have.

  • The risk neutral. In the games center, those games that report a negative balance are not approached. But if you are open to games with positive expectations, why? Because although it poses a risk, as we mentioned before, they do not contemplate the risks; but the return of its profits.

We have 2 people, each one has the same possibilities to invest. Both have 1,000 euros. Investors who identify themselves as having risk-averse behavior consider risk variables such as safe interest rates and inflation in their environment.

Considering these details, they prefer to invest in a government treasury bond. Why? Because due to their solidity they have a safe return of 3% interest. Those who identify themselves as being risk neutral, as they do not consider risk, but rather benefits, choose to buy shares in a new company in full development. Although it has risks, if it is successful, its return will be higher than that invested in Government Bonds.

With these examples you will notice that it is very easy to distinguish the differences. We hope that studying these behaviors motivates you to be a risk-neutral person. In fact, it is the ideal behavior, because although it is a path of possible losses, you can also take advantage of opportunities to win.

Unfortunately, many companies like Insurance, their success lies in taking advantage of people’s fears. It feeds on fears of losing something. As a result of this, people end up paying high annual fees to keep what they have. We hope that they motivate you to act, you can also know the demographic characteristics of consumers to further expand the topic of economy.

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