Every day, people make decisions under uncertain conditions in a number of different scenarios (e.g. Is it safe to cross the street with a vehicle approaching? Should I invest in this stock?). Studies from different fields, including psychology, economics, and behavioral economics have established that most people are more risk averse, which is the tendency to prefer a specific but possibly less desirable outcome, than reward driven, e.g. the tendency to go for the potentially greater outcome. Here’s Why Are People More Risk Averse
Risk averse individuals prefer to invest in safe but low yield possibilities, e.g. bonds, and select employments positions that are more likely to be stable even though they have less potential for advancement. Risk aversion influences decisions in many other areas. For instance, risk averse individuals are less likely to engage in unhealthy actions, e.g. drinking or cigarette smoking, etc. Read on to learn why this happens.
Overall, This Is Why Are People More Risk Averse
There are a number of different factors that cause risk aversion. The primary causes include socio-economic factors, wealth, and cultural background.
Socio-Economic Factors
Socio-economic factors have a key role in a person’s disposition to risk aversion, with social hierarchy proving to be a solid indicator of one’s level of risk aversion. Individuals with power are less risk averse. The reason behind it is that the powerful individuals are generally in a better position to tolerate a loss in case it occurs, because of their network and wealth. Because of this, they give less weight to risk than the ordinary individual, as losses are less risky endeavors for them.
Wealth
Similar to power, wealth also plays a key role in a person’s risk aversion. Rich individuals generally have an easier time tolerating losses that they suffer. A key aspect about rich individuals and their risk aversion levels involves their social environment. According to a study performed in Vietnam, the rich and wealthy villages were less risk-averse as opposed to poor villages. But rich people, who lived in poor environments, were more likely to be risk averse as compared to poor individuals who were to live in a wealthy village.
Cultural Background
Cultural background has been linked to how risk averse a person may be. Dr. Mei Wang surveyed groups from 53 different countries and conducted this study to understand how the various cultural values affect a person’s perception of risks compared to rewards. The study found that individuals from Eastern European countries are generally the most risk averse, with people from African countries being the least risk averse.
Is Being Risk Averse a Good Thing?
Yes and no. While it can be useful to be risk averse in many situations, it isn’t necessarily beneficial in other scenarios. The most important decisions we face usually require incurring losses and being risk averse can sometimes prevent us from making logical choices because the fear of loss is simply too intense.
How to Avoid it
Risk aversion is a common tendency that exists to help people minimize losses. That said, it is important to know how to avoid this tendency and the influence it generally has on decisions, particularly when making decisions with potential rewards. There are two primary approaches that can help:
Framing
The way a transaction is framed can drastically influence one’s perception of risk aversion. Framing a question as either a reward or a loss can change your decision or response. So, when you are faced with a decision that could be influenced by risk aversion do this. It is recommended that you frame the question differently to highlight the potential reward of a transaction.
Putting Loss into Perspective
Another excellent way to avoid risk aversion is to ask yourself: what the worst outcome would be if your take the course action. Generally, this helps individuals put risk and its related feelings of loss into perspective. In doing so, it allows them to better rationalize whether or not it’s worth making a decision.
The Bottom Line
Risk aversion is common in our everyday lives. It is predictive of a wide range of important decisions including health behaviors, healthcare decisions, portfolio allocation, and occupational choice. Risk aversion is particularly common when individuals deal with financial decisions. There are a number of factors that influence this tendency, e.g. socio-economic factors, cultural backgrounds, wealth, etc. While being risk averse has its benefits, it can lead to bad decision-making. So, it’s important to know how to avoid it. The above-listed methods will help you in this regard so that you can take well-calculated risks with potential for great rewards instead of fearing the incurring losses.
We hope you enjoyed this week’s article and hope to see you next week for our next article. Till next time!- The Black Sheep