What is risk-seeking? Definition and meaning
Risk-seeking or risk-loving describes a person who cannot get enough risk. He or she prefers an investment with an uncertain outcome rather than one with the same expected returns and certainty that they will be delivered.
If you offer either $100 guaranteed or a 50% chance of either $200 or $0, a risk-seeking individual will prefer the $200 or nothing option, even though both options have the same **expected value.
** The ‘expected value’ of something – when you have at least two options – is the sum of what is offered divided by the number of possibilities. For example, if you have a 50% chance of winning either $200 or $0, the expected value is: $200 plus $0 divided by two possibilities, which equals $100.
Investor Words has the following definition for risk-seeking:
“Attracted to risk, meaning an investment with a lower expected return but greater risk would be preferable to a no-risk investment with a higher expected return.”
Risk-seeking traits are more commonly found in people who have nothing to lose, compared to those in secure and well-paying jobs – they are more likely to be risk-averse. However, risk-seekers who are financially secure do exist.
Risk-seeking, risk-averse & risk-tolerant
The opposite of a risk-seeking person is a risk-averse individual. Risk-averse people prefer certainty – they don’t like betting on uncertain outcomes. Risk-averse people live by the idiom: “A bird in the hand is worth two in the bush.”
A risk-tolerant investor, on the other hand, will seek more of a balance between stability and risk, and will include more fixed income and value stocks in his or her portfolio.
A risk-neutral person is completely insensitive to risk. He or she is only interested in the potential return, and ignores the potential losses or risks completely.
What type of investor are you? Investment experts say that one of the most valuable things we can do is to inventory our personality and get to know ourselves as investors.
Most decisions we make are not random ones – they are driven by a range of factors that make up who we are, what we desire, what we need, how we anticipate things, and what we fear.
The curvature of the utility function of the 3 investors in this image tells us whether they are risk-seeking, hazard-neutral or risk-averse. The convex-shaped line corresponds to the risk-seeker, the straight line to the risk-neutral individual, and the concave shape to the risk averse investor. (Image: adapted from math.stackexchange.com)
The following quote comes from BinaryOptionsBrokers.ca:
” The better you understand yourself, the clearer your decisions will become. Knowing whether you pursue risk or avoid it can help you understand mistakes you make and choose a trading system that suits you.”
“Are you a risk-seeker or a risk-avoider (risk-averse)? You may instinctively know the answer to this question without having to think about it. This is likely only the case though if you fall near one extreme or the other.”
This article has explained what risk-averse, risk-seeking and risk-neutral investors are like. That does not mean there are three distinct categories.
The three categories represent part of a spectrum with infinite points in between. I might be a moderate or extreme risk-seeker, you may be a moderate or extreme risk-averse type of person. Very few individuals are completely risk neutral. However, we all have a tendency towards one of the types described above.
In the world of investing, risk-seeking individuals typically seek out investments such as international stocks and **small-cap stocks – they prefer growth investments to value investments.
** Small-cap refers to companies with a relatively small market capitalization.
Experts say that the risk seeker needs to carry out even greater due diligence than other types of investors, given that what he or she is about to purchase carries greater risk.
The term risk-seeking may also refer to a person who is willing to give up a secure job with a regular salary in order to start his or her own commercial enterprise.
Most self-made business people, at some point in their lives, had to make a choice between security and uncertainty, but with a chance of a greater financial and emotional payoff.
David Cummings, an entrepreneur who co-founded Pardot, a Saas-based marketing automation application that enables marketers to create and deploy promotion campaigns, wrote the following in his website regarding risk and whether he is risk-seeking:
“When people tell me I must love risk because I’m an entrepreneur I always respond that it feels less risky to me to be an entrepreneur. Why? I have a strong locus of control and want to own my destiny. As an entrepreneur, I’m ultimately responsible if we win or lose. That’s how I like it.”
“The next time someone says ‘that’s so risky’, ask them if there’s an irreversible component to the potential negative outcome. If the outcome is reversible, and has a reasonable chance of success, it’s likely less risky than perceived. If fact, most decisions and the resulting outcomes are reversible.”
A risk-pursuing negotiator
The term is also used in negotiations. A risk-seeking negotiator adopts a high level or approach in the amount of risk that he or she is prepared to accept in a negotiation.
The negotiator who chooses not to accept a ‘sure thing’ and goes for the long gamble, and who expects more may be gained in a negotiation that most other people (in the same situation), is said to be ‘risk-seeking’.
Video – Risk seeking
In this video, Dr. Scott Brown quoted the American economist Milton Friedman (1912-2006), who in 1948 published a paper in which he stated that risk-seeking is much more common in people who have nothing to lose.
A person who has lost everything is much more likely to take big risks than somebody who has just won the jackpot or has a secure, well-paying job, he said.