Risk-Seeking

What Is Risk-Seeking?

Risk-seeking is one's acceptance of greater risk, in finance often related to price volatility and uncertainty in investments or trading, in exchange for the potential for higher returns. Risk seekers are more interested in capital gains from speculative assets than capital preservation from lower-risk assets.

Risk-seeking can be contrasted with risk-averse.

Understanding Risk-Seeking

Risk-seeking individuals leverage the trade-off between risk and return by accepting more risk in hopes of above-average returns. In general, higher-risk investments demand higher expected return potential, although the quality of the asset in question must be considered beforehand to ascertain whether there is sufficient return potential to justify the risk involved.

Some examples of types of assets that risk-seeking investors would be attracted to would be small-cap equities, derivatives, emerging market equities and debt, currencies of developing countries, junk bonds, and commodities, to name just a few.

Risk-seeking might also describe entrepreneurs who are willing to give up the stability of salaried employment at an established company to start their own companies in the hope of a greater financial and emotional payoff.

Special Considerations

Risk-seeking behavior tends to rise in bull markets, when investors, encouraged by gains in the financial markets, are coaxed into thinking that the good times will continue. There is always a subset of risk seekers who orient their strategies around high-risk/high-return investments. Others, however, may shed their discipline to chase momentum stocks, for example, or try their luck with a hot initial public offering (IPO) that they know little about.

Risk-seeking is an equal opportunity activity sought out by retail investors and professional fund managers alike, but it can go too far. Examples of when risk-seeking behavior caused many investors and speculators to lose huge sums of money include the dotcom bubble of the early 2000s and the housing bubble of the mid-2000s.

$17 trillion

The amount lost in U.S. household net wealth from 2007 to the first quarter of 2009 after the collapse of the housing bubble and onset of the global financial crisis.

Risk-Seeking vs. Risk-Averse

Risk tolerance is an important concept for investors and refers to the degree to which an investor is willing to accept risk for the potential of a higher return. Risk-averse investors opt for low-risk investments and are willing to accept a lower rate of return because of the desire to preserve capital.

Financial advisors endowed with common sense counsel their clients to minimize risk-seeking behavior with respect to their investments. In many cases, particularly for younger individuals, risk-seeking is part of an overall investment strategy, as risk assets can provide a boost to total portfolio returns.

For individuals who need more certainty of funds for an imminent house down payment, college education, or retirement, lower-volatility investments are recommended. Risk-averse investors would prefer to look to assets such as government securities, blue-chip dividend stocks, investment-grade corporate bonds, and even certificates of deposit (CDs).

High-Risk Portfolios

Risk-seeking investors will often construct a portfolio of high-risk investments that they believe have the potential to reap high gains. There are various strategies investors can employ to construct a high-risk portfolio.

One strategy is to create a concentrated portfolio focused only on investing in a single sector or industry, such as technology. This type of portfolio can work best for an investor who already possesses knowledge of the sector and understands it well.

Another strategy for a high-risk portfolio is momentum investing. This method relies upon working with volatility and seeking investments that are already trending up. The momentum investor is not looking for a long-term investment but instead wants to capture short-term gains and sell the investment as soon as momentum wanes. Several timing risks exist with this strategy, such as getting into a position too early or closing out too late to achieve the best gains.

Other strategies for building a high-risk portfolio include investing in currencies, options, or futures. Each of these asset types uses the power of leverage, which enables investors to multiply their buying power in the market. To be successful in these strategies requires investors to be well-educated in trade execution and research. Investors need to monitor these investments closely, be able to stomach fast-paced trading scenarios, and be able to develop an exit strategy to preserve capital and gains.