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Risk Aversion: Why Do People Treat Risk Differently?

September 6th, 2020 by 
CameronDaniels

One of my coworkers very recently moved to this state from across the country. In doing so, he had to pick up his family, sell his house and buy a new one all while working remotely, traveling back and forth and transitioning to a new area (and climate). We got to talking about real estate and what he was looking for when he bought his house and some of his answers were quite revealing. He bought his house in cash, completely avoiding debt due to a strong preference from his wife. This revealed two things to me, both about my own risk aversion:

  • As a single man, I haven’t had to experience the push and pull between risk tolerance of a couple
  • I have a much higher tolerance for debt than most

Why is he so risk adverse when it comes to avoiding debt?

When I pushed on the topic a little bit, I came to recognize he had not thought of the tradeoff too actively (like we tend to do here).

He is rather young so he has quite a few years until retirement and could use the debt to invest more in a nest egg. Asking how long he wants to work, he answered ‘forever’, an answer which, while different from my own, should imply that he has a higher risk tolerance than myself. Paying a house in cash is something that I believe I will never want to do. The power of leverage tied with my age means avoiding debt in the form of a mortgage - I will always be getting a mortgage to amp up the amount of assets my equity will be able to buy!

This issue manifests itself in the PF world as well. We at DQYDJ have complained about debt aversion in the blogosphere quite enough and have been told that a lot of the explanations are psychological and security.

A Dave Ramsey follower will preach that debt is a plague or a disease that bears down on you that you need to fight off and have much different opinions on avoiding debt than we do.

As for me, I’m a little upset that I can’t get more debt. My debt burden is too low. At my age I should be seeking as much debt as possible (tied to appreciating assets) so that I can use my youth as an advantage. With the money I would pay down my mortgage, I would just as soon buy another house with another mortgage.

A man who understands leverage - call it risk aversion zero.  No avoiding debt for him!

A man who understands leverage - call it risk aversion zero.

Why do I have so little risk aversion?

Part of my debt tolerance is due to my age.

Being young and in a career where I feel potential for income gains is significant means focusing on reducing debt (VERY different from reducing expenses, please note the difference) is not the best use of my money. Acquiring assets and using the power of time is something that you can never gain back - so I am comfortable dialing up the investment risk. If you’ve been reading some of my series, you have recognized this mentality has manifested itself in my preference for adjustable rate mortgages (and adjustable rate energy prices, mind you). Heck, I’d get an adjustable rate auto loan if they were offered.

Another part of where I am comfortable is that I am single.

Without somebody else to take care of or recognizing I have a family dependent on me, my risk aversion is surely different. My coworker who said he wants to work forever may always have that desire, but he may not always have the means. Injuries and health issues crop up without asking for them. Perhaps it is a sign of my immaturity that I cannot see myself relinquishing control of my risk tolerance to somebody else, but for now I will continue to seek as much debt and leverage as possible: remember, too, there is a risk in not taking on enough risk. Unfortunately, my leverage has dropped from about 7:1 to 5:1 in the past few months.

Cheers,

Cameron Daniels

P.S.  For some good reading on investment decisions in relationships, read my coworker's article.

Don't Quit Your Day Job...

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