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Life is risk, and what to do about it
Thursday, 24 August 2006
There's a growing myth in today's world that we can somehow reduce risk to nothing. If people lose money on an investment, they're outraged, if they hurt themselves while undertaking dangerous activities, they're shocked. "Safety whatever the cost" is the motto of our age.
These beliefs overlook a reality that's unlikely to change anytime soon - life is risk.
In everything we do and everywhere we go, we face large numbers of dangers. That's just the way things are and we all have to deal with it. That's why risk management is such an important thing to understand.
Most people's first reaction to risk is to try to reduce it as much as possible. But that's only looking at half the equation. For any steps you take to mitigate danger carry costs. You have to be able to weigh-up those costs against the benefit of reducing the threat.
This is easiest to understand in the area of finance. Putting your money into government bonds carries less risk than putting it into a tech start-up. It's unlikely things will go so badly wrong that the government will be unable to repay your money, but highly likely the tech-startup will find themselves in that situation.
That's why a smart investor demands a higher return from a tech start-up - to compensate them for the increased risk. At the same time, an investor should be willing to accept a lower return from the government, as their money is likely safer. By choosing government bonds, investors accept the cost of lower returns in exchange for less risk.
A really smart investor gets good at assessing these cost/risk trade-offs. Obviously, there comes a point where the cost of a smaller return far outweighs the risk of losing your money. If the government is paying 0% per annum and the tech-startup is paying 1200%, then you'd be mad to invest in the government. The start-up only has to survive over a month for you to make more than your money back.
Obviously this is an extremely exaggerated example. I've done so to highlight that at some point, you cross a line where the cost of avoiding the risk outweighs the chances of a negative event occurring.
You can take this logic into everyday risks as well. Every time fly in a plane, for example, you risk being killed in a crash. Most of us are willing to accept this risk because of the benefits air travel brings. We could completely eliminate death through plane-crash simply by banning air travel, but in that case the cost of reducing the risk would outweigh the risk itself.
On the other end of the scale, wearing a helmet while riding a bike is risk-reduction that's worth the cost. A helmet costs little and doesn't reduce the enjoyment of riding. In the fairly likely event you fall off at some stage, the helmet can protect you from serious head injury.
Of course, losing money and sustaining injury aren't the only risks we're exposed to. Our reputations, emotional well-being, relationships and many other factors are also often at stake.
Spend some time looking at the risks in your life from a number of different angles. Train yourself to be able to identify them in all the different spheres you move through. Weigh up the possibility of things going wrong in any particular situation and the cost of reducing that risk.
The questions are:
- What's the danger?
- What could reduce it?
- Is it worth the cost of reducing the danger?
Good luck in managing the risks in your life by making informed decisions.
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