We may not think about it, but relationships go much further than the ones we have with the people around us. In fact some of the most important relationships are the ones we fail to realise even exist.
These are the same relationships that shape and dictate our behaviour through every day events and actions through to some of the biggest decisions of our lives.
One of the most important relationships that you may not even know you have is your relationship with ‘Risk’ – the relationship that determines when you ‘take a chance’ and ‘when you don’t’.
So what makes this relationship so important?
Lets find out.
- So What is the definition of Risk?
- Why we take risks
- Avoidance and Management: Risk Analysis
- More things to think about
- Why avoiding Risk is the riskiest thing you can do
So what is the definition of risk?
In short risk is how we think about the potential downside or loss of something valuable. The value can be one of, or a combination of many things, including financial (personal), economic (commercial), technical, time, informational or even human value.
This means that risk is not just down to one thing, but has many broad potential factors and make the issue of managing risk multi-dimensional, however for the purposes of the article the prime value we will look at will be monetary, both financial and economic.
Related: Why you can’t buy back your time … Yet.
Why we take risks
Why do 8 million Australians play the lottery? Why do people gamble? Why do people invest?
On their own each of these can seem quite frivolous. The odds of winning the lottery are over 8,000,000 : 1. The odds of winning at the casino depend on the game, and the return on investments vary … and in uncertain times such as these [Re: Covid-19], more than ever nothing is certain. In fact in uncertain times, even the safest of strategies have turned out to be vulnerable to this black swan event.
Yet people still decide to participate, to play and to invest. Why? Because the potential upside can be so beneficial and the benefits can dramatically change the financial or the economic situation for ourselves, in a much shorter time frame.
We take risks, because the lowest risk path is often too slow or may not even be able to achieve the objective at all.
We take risks, often because … our goals simply need them to be taken.
Related: Why jobs aren’t safe anymore and neither are you
Avoidance and management: Risk analysis
But taking risks because we might need to is still irresponsible. It is about taking the right risks at the right times. And that means … completely avoiding risks where the negative outcome is crippling or absolute, while trying to manage downside outcomes where the negative outcome is survivable all while comparing it against the potential gain. And there are some key steps that come into this analysis.
Knowing how to plan for it is something that can be easier said than done, and there is almost no way to completely immunize oneself against potential risks and their downsides. But firstly there is the issue of …
Knowing the variables involved. Whether it be starting your own business, working a job, or gaining passive income from investments or keeping your money in a bank, everything has a risk that comes with it.
More often than not, the lower the risk; the safer a strategy … the lower the returns are.
As an example putting and keeping money in a bank is seen as a low risk strategy, but today  compared to 1990 there is almost no upside.
Investing is seen as the best way to make your money work for you, but at the time of writing market value and volatility means there are risks that need to be managed and assessed prior to making any sort of commitment to any market.
Working a job is ‘normally’ a safe way of earning income, but once again at the time of writing we have also seen just how fragile whole industries can be and how as many as 1-in-12 jobs can be sacrificed in as little as a month from an industry shut down.
Knowing the variables, even when they are 2nd and 3rd order, they can help with managing risk.
More things to think about
Getting information on the current situation that you could commit to is another major factor involved when it comes to managing risk. Today almost no sector operates in isolation but having access to key information is critical to the process.
Diversifying and spreading the risk amongst various options is another factor that can lower the impact of potential negative outcomes. When diversified appropriately it is far less likely to see your entire portfolio get attacked in a downturn. Instead losses in one area can be offset by gains in another. However diversification means conservative gains when one area grows significantly.
Assessing the scenarios and making escape plans is another way to reduce the full force of downside events. The upside outcome is most often considered as a reason to take a risk in the first place, however when both sides of a strategy are assessed – special conditions should be taken into account, not just for exit, but these key conditions should also serve to trigger potential further commitment. The recent stock market sell off is evidence of one such case.
Once plans are made with positive information that is available, there is the utmost importance to Execute the plan and monitor the situation at all times. Attention to the timescales needs to be maintained in order to filter out the noise and identify key moments, both for capital gain and loss mitigation.
In the end managing risk is part of your strategy and although no strategy is perfect, once you have one stick to it.
Related: How Low interest rates impact your future
Why avoiding risk is the riskiest thing you can do
When we talk about risk avoidance and risk management, we often think about the downsides and potential losses that can come with them.
No strategy is perfect and no matter what we plan for, there can be unforeseen circumstances which can see us take losses, and above all else, leave us with a foul aftertaste for taking risks, no matter what the outcomes could be. In fact risk avoidance, is so powerful that even when overall risk levels are low we will often choose to do nothing because it is seen as safer [in the short term] than taking near certain gains in the mid to long term.
Today entire industry sectors are being wiped out – due to a once in a lifetime event. And when passive financial performance is so low, taking calculated risks for your financial future is a near necessity. But there will still be those whose relationship with risk is so toxic, that the lowest risk pathway, will still be taken even when it is guaranteed to fail reaching the end objective … such as committing to a time trading job, when it neither offers financial or even professional security.
The relationship we have with Risk is one of the most important relationships we have.
So what makes this relationship so important?
Because it determines how you can get to where you want to go, how quickly you can get there and all of the costs involved, not only if something goes wrong, but also if and when things go right!
Related: How you’ve been setup for financial failure