How do you define risk? What comes to mind when you hear word risk? Fear? Pain? Lose? Gain? When it comes to the word risk we all have a different view on what we consider to be risky? We each have different thresholds with risk depending on the situation. While our definition of risk is far from a universal one; we tend to view risk from a dated point of view. Risk, for most of us, is a risk/ reward proposition. Put another way, we perceive it as a black and white debate where you risk losing something in order to gain something.
Life isn’t black or white; rather it consists of a lot of greys. While it’s tempting to try and view risk from simply a risk/ reward standard point, it often doesn’t work. With respect to finance, it’s simply an inadequate way to view risks because financial decisions go beyond your risk tolerance. Financial decisions are emotional and involve a lot of grey factors when we tend to believe it’s simply black and white.
I haven’t taken a poll but if I had to guess, I would say half the population is risk adverse. They rather avoid risk if possible and play it safe. Most of us take risks on things we shouldn’t from a statistical standpoint while accepting risk on things we shouldn’t from a statistical standpoint. A common example is workplace lottery pools. Most participants in an employee lotto pool find the pool to be far safer than investing their money in the market. Statically, investing your hard earned money into a monthly work lotto pools is a poor investment decision while investing in the market offers a far greater probability of success. But those odds don’t really matter to lotto office participants either because they don’t care about the odds, view it as an innocent activity, or they actually believe the lotto their best chance at retirement. The question is why? Why would someone find it safer to put $20 or $40 per month into a lotto pool that statically the odds are not just against them but not even in their favour?
The answer? We all view risk differently. The lotto pool contributions are small enough that most participants do not see the long term damage their $20-$40 is doing to their financial future. Our individual experiences shape our view of what we consider risky or not. We do not all share the same life experiences and our individual experiences are how we view and analyze the world we find ourselves in. Your risk is as real as you believe it to be regardless of what the statistic says. That’s why it’s critical you first reflect on your childhood and personal life experience to understand your risk profile. It’s not so much about risk and reward as it is about your life experience exposure and how you use those experiences to determine what risk comfort level you’re okay with depending on the situation.
That being said there are some things we all should consider when thinking about risk. First, stop viewing risk as simply a gain or loss proposition. Life is far more complicated and the idea that the only way you can provide for your family or have a good career is by taking a ridiculous amount of risk is dated. Secondly, life is full of risk and we take risks every single day. The difference with our everyday life risk decisions is we mitigate most of them unlike what we do with financial risks. For example, when driving we know there’s a possibility we could get in an accident that could result in our death. The risk doesn’t prevent us from driving because we weigh the benefits and risk of driving. But more importantly, we do things to reduce the risk factor so feel more comfortable about driving. Some of the things we do include; wearing a seat belt, avoid texting while driving, and leaving on time to name a few.
Risk isn’t something you avoid; rather you should ensure you’re aware of the risk factors involved and develop a plan to either eliminate or mitigate the risks.
Lastly, incorporate your goals and objective when evaluating personal financial risks. Let’s assume you want to retire in 30 years which requires an investment portfolio that’s more aggressive to try and hit that goal. From a traditional risk view, you simply would say no and select an investment portfolio that suits your risk comfort level. But if you factor in your goal that you want to be able to retire in 30 years the question is different. What’s the bigger risk? Not being able to retire in 30 years or having an investment portfolio that you’re comfortable with but will not meet your goal of retiring in 30 years? I’m not suggesting everyone become an aggressive investor to meet their goal. I’m simply suggesting when you include your goal into your risk analysis it changes how you frame the risk question. Having the money is pointless if it isn’t enough to reach your goal to retire since that’s the reason why you started to invest in the first place. Goals are important to factor into your risk assessment because ultimately that’s what you’re trying to achieve within an acceptable risk level.
Risk. It’s a scary word but it doesn’t have to be as long as you stop viewing it as simply a loss or gain proposition. Do not avoid risk but rather take the time to understand the risk factors and put a strategy in place to either eliminate the risks or reduce the risk level.