Changing your relationship with risk
The fear of risk and uncertainty holds us back from testing ideas and pushing ourselves forward. So how can we change our relationship with risk and uncertainty? The answer may may lie in how we frame it.
Risk is scary
Whether we’re thinking of starting a business, taking a gamble on the share market, or perhaps telling someone special how we feel, there is an element of uncertainty associated with all of these actions. Uncertainty comes packaged with a variety of negative emotions which we have evolved to avoid; fear, disappointment, rejection, this list goes on. So, risk = uncertainty, and we generally dislike uncertainty.
On the flip side of this, we see that, as a society, we benefit from and even idolise those who are able to push through their aversion to risk, and find success on the other side. If the fear of uncertainty is a barrier which keeps the majority of us at bay, those who are capable of pushing through this barrier are operating at a level with fewer competitors. Why then do we still make decisions largely ruled by the fear of risk? Surely, having seen so many success stories from those who have pushed through their fear to find glory on the other side, we would all have adopted this behaviour.
I believe that the answer may lie in our framing, or perspective of risk, and how we perceive the numbers behind it. This idea is largely influenced by Richard Thaler’s book ‘MISBEHAVING’. If you haven’t read it, I highly recommend it. Imagine this scenario, you are 1 of 23 executives in charge of a department within a very large business. An investment opportunity is presented to you with the following potential outcomes; after the investment is made, there is a
- 50% chance that you will lose $1M
- 50% chance that you will profit $2M
Would you take the opportunity, or turn it down? 1
It turns out that the majority of executives who are asked this question will turn it down. It is far too risky for them to justify. 1
This intuitively makes sense — if the project is a success, you, as the executive are likely to receive some congratulatory sentiments and perhaps a larger bonus for your troubles. If it fails, there is a good chance you’ll be fired. On the scale of the individual, the risk to reward ratio is perceived to be too risky.
Now zoom out and imagine that you are the CEO of this company. Assuming that each of these projects is independent of one another, you would want every single one of your executives to take the risky project on.
Why? The expected, cumulative outcome of this equation is +$11.5M dollars. [23*((.5*-1M)+(.5*2M)) = +$11.5M] 1
An expected outcome of +$11.5M is a good deal. So why do so many executives not take the risk? (As we are focusing on how we can apply this to our daily lives, I will, for now, not consider things like the company’s culture or remuneration structure.)
The answer, I believe, is the narrow individualistic lens through which projects like these are considered.
Taken on a case by case basis, the risk appears to far outweigh the benefit. However, when you consider the cumulative effect of these projects, we change the way we perceive the risk. Mathematically, this is illogical. If it makes sense to take the risk 23 times, it makes sense to take it once. However, in reality, we don’t behave this way.
So, how can we use this to our advantage?
If the problem lies in our perception of a small number of risks, which, when considered individually sound unappealing, but sound less so when considered as part of a greater whole, we simply need to incorporate more risks into our lives, and consider them as a part of a greater pool. What I am referring to is essentially diversification. An investment tactic as old as investment itself, in which you spread your risk over a greater number of investments, ideally in different sectors. We can replicate this tactic in daily life.
As a starting point, one might take on numerous, smaller risks and lump them together under banners like ‘work risks’, ‘investment risks’, ‘starting my own business risks’. ‘Work risks’ might not work out one month, but that’s ok — it’s a part of a broader risk portfolio, and chances are that by taking that risk, you learned something valuable. By taking on more individual risks, we do two things;
- We change the way we think about risks and start to train ourselves out of risk aversion.
- We start to push ourselves outside Of our comfort zone. Beyond comfortable we may find disproportionate payoffs, but we will certainly learn lessons we otherwise wouldn’t.
By taking a more active approach to risk and becoming more comfortable with uncertainty, we trend away from inaction towards action. The more comfortable we are with uncertainty, the more capable we are of testing and learning from ideas. If we maintain an aversion to risk and uncertainty, we sit on ideas, never pushing them to fruition where we might validate their merit.
Aversion to risk leads to ideas being incubated for too long
We want them to succeed so much that we focus on making them ‘perfect’ rather than good enough to test. The trick is to keep the individual risk low by testing it early and learning from the experience.
In closing, we can leverage our mind’s tendency to accept more risks when considered as part of a greater whole in order to change your relationship with risk and uncertainty. It is a slow process, but we can start to shift the way we think about risk and how we interact with the ideas we have.
1. Thaler, R. H. (2015). Misbehaving: The making of behavioral economics. New York, NY, US: W W Norton & Co.
2. Illustrations by Jodan Cook