There are a lot of psychological elements that play a role in how comfortable we are with risk and what we’re willing to lose in order to gain. These elements are an integral part of our financial lives and how we invest money.
For example, there’s a term called loss aversion, which is a cognitive bias that means that your losses hurt twice as much as any equivalent gains. This relates to risk aversion as well.
Risk aversion is your tendency to try and avoid risk. In investing, this would describe someone who focuses on preserving their money instead of going for potential returns that are higher than average.
Risk is price volatility in investing, and if you make a volatile investment, it can lead to wealth or it can also deplete your savings.
If you’re conservative in your investments, then they grow steadily but slowly.
Low risk is more stable, but your returns might not be impressive. The flip side is that you have an almost zero likelihood of losing your original investment. The problem is that along with not generating much wealth, you might not even be able to keep up with inflation over time if you only stick with low-risk investments.
We can think about the stock market and other financial investments as well. For example, buying a second home as a vacation rental can be a high-risk but high-reward investment.
Smart investors know how risk-averse they should be based on their situation, and they’re also willing to take risks.
If you have your money sitting in a savings account and that’s it, you may be extremely risk averse.
The following are things to know about being less risk averse for better possible returns but knowing how to keep a sense of balance.
Know the Signs You’re Too Risk Averse
Again, some risk aversion is good, but there are signs that you should watch for that you’re not taking enough risks.
First, is your retirement account growing at a very slow pace? You might want to gain more exposure to risk, especially if you have a long time until retirement, which would give you a chance to make up for losses.
Other signs you’re too risk-averse can occur in different parts of your life. Maybe your career is stagnant, or you’re afraid to invest in yourself by doing something like going back to school. You might refuse to move for a job, even if a better opportunity came along, or maybe you’ve been toying with the idea of starting your own business, yet you won’t take the leap.
Inaction can be as detrimental to your life and goals as too much action. Sometimes, it’s more harmful.
If you’re someone who has essentially zero risk tolerance, start small with decisions that aren’t going to be life-altering. Maybe, for example, instead of deciding you’re going to go back to school, you take a course online.
If you own a business, maybe you decide to diversify your product offerings, but you start with a digital product that’s low-cost to produce and gives you a chance to experiment a bit.
You don’t have to be all-or-nothing when it comes to increasing your risk tolerance.
As far as investing, maybe you put a small amount of money in a single stock rather than a mutual fund or ETF. Do some research to find one you believe in, and only put money in that you’re okay with losing.
Then, depending on how these smaller decisions go, you might be willing to take larger risks going forward.
Framing these small decisions as experiments can be more appealing, especially when you realize even the downside possibilities won’t mean the world comes to an end. You’ll build more confidence with each risk that you take.
Create a Portfolio of Options
You’ll often hear people talk about a portfolio of options in business. This means you aren’t going all-in on one thing. Instead, you’re offering yourself a lot of possibilities that could lead to successful outcomes.
If you can put together a group of initiatives, it seems less scary if one fails because you know that some of them might succeed.
If you feel like your options are limited, risks become much scarier.
If you think about this in terms of investing, it’s essentially diversification. You’re spreading out your options. If you’re diversifying your investments, your portfolio will include assets and also asset classes that aren’t all correlated with each other. If some of your securities fall for a period of time, others might rise, and you’re offsetting your losses.
Stop Making Perfect Your Goal
If you’re aiming for perfection in any part of your life, whether your business or career or your finances, you’re always going to fail because it’s not possible.
Don’t let perfect be the enemy of done in any part of your life.
For example, maybe you want to write a book. You’ve started working on it, and it’s nearing a point of completion where you could potentially earn money from it. Unfortunately, you never think it’s good enough, so you never take the risk to put it out there. Again, it will never be perfect, so let it be good enough.
This is something you have to embrace throughout your life, and it’s tough, especially if you are someone who’s very risk averse, but if you understand you’ll never achieve perfect, you’ll be able to make a lot more progress.
People who always aim for perfection tend to get stuck and be more stagnant.
Finally, don’t focus too much on your end goal. That’s going to make you scared to take risks, and you might be paralyzed in your decision-making. The first step is what you need to think about—not the end outcome. That could be years away. Taking the first step, as cliché as it might sound, is the most important thing you’re going to do.
If you’re nervous about something, break it down into very small steps, and make the first one as easy as you can on yourself. For example, if you want to start saving for retirement, start an account and put aside $20. That’s all you have to do, and you’re started working toward your goal.0