When the term “risk” crosses our minds, the first thing we imagine is danger threatens our lives, these hard life-decisions which we face once or twice in life. Yet, the risk is what we encounter and tackle on a daily basis in life. For example, how you take the risk of delayed arrival to work when you take back the devilish idea of not going to your job office on time. Also risking good food when you enter a restaurant for the first time. Yet, the risk you take is worthy only because of the possible prize; if it will be seeing your family rather than going to work or trying a good meal at a new restaurant.
The issue is that plenty of us got a faulty concept of the actual meaning of risk. We visualize it from the angle of cause and effect approach. When you do A, then B is what happens. Yet, life is more complicated than this. Each risk has a series of possible outcomes. If we don’t consider these results, we’ll take a lot of time living in the problem.
This summary takes us to see the most typical and known misconceptions regarding the meaning of risk. We’ll understand and prevent such traps through monitoring the way in which people who occupy very risky careers deal with it. Is it live on a stick or millions of dollars on the line. Monitoring those individuals will enable us to know the way to face revealed risks cleverly in our lives.
Chapter 1 – Every risk must be considered in light of an explicit specific aim.
How would you react when the time comes for a striking, risky decision? Do you just jump to it no matter the outcomes? If yes, then perhaps it’s better to rethink your plan.
How do you decide to take a risk when no plain aim is ahead of you? This is not possible. Therefore, you should determine a final aim first. Imagine it in your mind and make it precise. In case you are considering a new career for having a better income, think of the aim of what you need that money and all the costs that you’ll give to get to that aim.
When you determine that aim, consider all the paths that you probably would take to get to it with minimum risk or none at all. If you have riskless ways, why will you bother taking another?
Well, it’s hard to have this situation all the time. Some of your aims will have risky decisions. And in some cases, the risk-free choice isn’t available for real or what you wished for.
For example, you’re searching for a house. You’re looking for specific area size, location, and cost. Now, most likely you will get what you are looking for but it will add more expenses to ensure the winning bid. If this is beyond your budget limits, perhaps you will choose a smaller house. The risk-free option, the capability to pay all the required costs for the house might be impossible for you.
Let’s have a more drastic story: Nevada’s legal brothels. Coitus employment is among the riskiest careers in the globe. Women as employees in this sector gamble with their own security, their well-being, their reliability, and almost in all states, they risk being captured by police. Yet, they do the job because it can be greatly profitable. Their aim is to have a high income.
Leasing a room in a legally registered property drops or lessens a great deal of risk attached to such a job. The coitus employees must get a periodic health check and bodyguards to protect them from any possible bad clients. Yet there again, the risk-free option is not free of costs. Moreover, adding to the expenses of moving the employment location to Nevada, women have to pay around 50 percent of their income to the brothel.
Eventually, the reason lies behind each risk we take is one in each time: the cost of reaching our aim with a risk-free option is simply very high. Yet, what does help us in choosing the worthy risk? No clear-cut answer for this but the next sections will show us a few ways to see unworthy cases for risks.
Chapter 2 – Previous outcomes are a bad reference to prepare for future risks.
How do you calculate the time to go to your office every morning? If we assume your average delay allowed for you id thirty minutes and you must arrive at your work by 08:00 a.m. Then, you most likely plan to leave your home at 07:30 a.m. and this is your exact time for getting to work, is that correct? The answer is NO. In fact, too many incidents may happen to unsmooth this process.
If you build your decision only on the fact that the ride from home to work is always 30 minutes, then you will arrive late at work eventually.
When we calculate risk, we don’t measure only one potential result. On the contrary, we study a whole range of issues that could imaginably occur. Of course, your routine travel to work takes almost half an hour every time. Yet, in case the whether id not stable, we realize that raising the possibility that a ride will take more time. We don’t expect an accident on the road every day that would create heavy traffic, but it could happen. Therefore, as much as it’s prominent for you not to be late for work, you will specify much time for your ride to avoid any delay.
We realize this approach very primitively when it’s considered for small routine choices. Yet, when it’s considered for calculating risk on more complicated situations, such as firm or economics, things go sophisticated.
In Hollywood, for instance, there’s a great deal of risk in filming movies, with the cost of millions on the stick here. So, if a movie hits the ground with its success, production firms will hurry for starting another similar movie. In case previous outcomes were a reliable method to prophesying what is coming, it would be very simple to copy the formula and launch only movies.
This far away from the truth. If you study the sales of film tickets in theaters that belong to a production company, you’ll find that it is not according to a typical methodology of distribution. Good movies make fortune. Yet, many fail to profit as much as few who lose money. This inclined distribution methodology brings more tough times of guessing which film will succeed and which won’t.
Another main issue with risk calculation is data. To guess an accurate risk, you need a steady rivulet of recent and critical data. Yet, data can be spoiled by rush. Box office sales, elections outcomes and financial progression are all particularly hard to be guessed since you may wake up one morning to find the data you’re looking for to study carefully has developed into new data.
Thus, whatever the case, if we’re going to our offices or achieving movie ticket sales, we ought not to calculate our risk based on previous experiences.
Chapter 3 – How we understand risk doesn’t rely totally on logic in every time.
Have you ever tried the lottery? Plenty of people do. And it’s a straightforward chance which most people realize the possibility of their loss. Eventually, the odds of catching the jackpot are rare. This means that we’re just gambling with money on the worthless lottery.
Therefore, with the possible declines surpassing the possible profits, or else, how do you explain the fact that plenty of us roll the lottery dice?
Economic experts believe that each person is risk-averse. And this is correct to a certain point. We definitely love to win. Yet, it’s not that easy. When we see all the possible results of a risk, we connect each of them to a feeling value. Economic experts call it a utility. And when we decide on something, utility becomes more important than the real value.
Think of yourself plying in a high-stakes poker tournament. The ultimate award is ten million dollars and it depends on you and one more player. You have two choices; either to try your luck in winning it all or to make a deal with the other player to share the award in half. Half of ten million dollars is a fortune, therefore, we’d most likely take this chance of a guaranteed award. Yet, if the other player is a person of wealth, by the way, it won’t make any difference to him. He’s probably going to keep playing for the sake of the game itself rather than the money.
Putting utility at first and value in the second can make us exaggerate the result. We pay so many feelings over issues that are actually very unbelievable to occur. Think of the lottery. Nobody enters the game with loss is considered, we all keep an eye on the jackpot. A jackpot that we’ll nearly never get for sure.
It’s simply to introduce risk in a manner that fills in such feelings appeals. Once more, consider the lottery example. How many times did the statement; “You can’t win if you don’t play” occurred to you? This is correct, but it’s realizing the possible risk by quite a little. Yet, how many individuals would enter the game if the statement was; “You can’t win if you don’t play and you probably won’t win even if you do”?
If we’ll accurately assess the possible risk, we must consider this disconnect and look at how the data are introduced to us. Let’s suppose that you found out that your medical treatment was tested and confirmed to maximize the chances of advanced anemia. You’d possibly consider not to continue with it, correct? On the other hand, if you really observed the study itself, you’d find that their results’ ratio had raised from 1 to 2 in 8,000. That’s a twice increment it isn’t that serious as it seems.
When we really realize the possible positivities and negativities of any specific choice, we can estimate and decide risk at best.
Chapter 4 – Variegation assists reduce superfluous risk.
Risk analysis makes two kinds of risk in terms of two large classes. Idiosyncratic risk is a single type for a specific sector or benefit. For instance, a shift in power at a certain firm in which you have stock would be an idiosyncratic risk. Systematic risk impacts the whole structure instead of only a person in a position. In the case of a financial slump, it’ll affect the whole stock exchange and not only your own stock.
Let’s concentrate on idiosyncratic risk. In what ways do you get ready for it?
Variegation is just an imaginary method of saying, “Don’t put all your eggs in one basket”. Among the popular practices of variegation, one can be seen in finance. Expanding your stock portfolio is one of the best ways to avoid idiosyncratic risk in finance. Yet, there are other instances of variegation in many sectors other than the stock market.
Do you recall the story about Hollywood we spoke of earlier? Production firms expand by forming a whole bunch of films instead of only one or two in a raw. In this strategy, successful films assist in compensating the costs of losing ones. In addition, they expand the medians of distribution, achieving sales at the theater tickets center, various home video formats, and issuing an authorizing rights to running services and television.
A rare instance of variegation in life can be seen in the realm of horse procreation. A champion racing horse controls hundreds of thousands of dollars in racing prices. At the beginning of entering the market, he’ll most possibly be procreated with well more than 100 female horses in an effort to reproduce his remarkable features. Yet, it’ll be no less than half-decade before his baby horses are known for inheriting those features. One path to raise the chances is to proliferate him with as many various females as they can during his popularity.
Nowadays, science and technology are improving the efficiency of variegation more than any other time. An expert in financial analysis can make a well-expanded path that decreases your possible risk in a stable way. Veterinary science is capable of gathering and procreating horses with their females with features that would raise the possibility of the desired baby horse. And when software programs’ ability fails to produce the best Hollywood film, data collection makes production firms able to give these films to the masses with more qualifications using digital downloads and running services.
Yet, variegation has a disadvantage. Removing the idiosyncratic risk decreases the possibility of a great blessing by making a huge investment in the next Google as well. And also the most various portfolios remain weak to systematic risk such as a stock market crisis.
Chapter 5 – Hedging and insurance work to prevent possible damage you might get.
Risk management tries to solve a quite easy dilemma. How can we decrease or remove the disadvantage when it remains in a hold on to the possible advantage? Similar to what we’ve discovered, variegation works for us to tackle idiosyncratic risk, yet, the systematic risk is tougher to be managed. It needs many possible solutions.
We all know what’s the meaning of the concept of hedging. If we say “hedging our bets”, this reveals the unlimited options we maintain. Hedging needs us to devote part of the possible profits to decrease our likelihood of loss. When you consider your total kine of possible results, you’ll see hedging eliminates the limits, both the positive and the negative.
Hedging systems can be simply found in the investment sector. When your fiscal consultant informs you to put part of your fund in bonds rather than in stocks only, you’re considering a hedging program before the uncertain behavior of the stock market. The bonds will not return big profits as your investment but at least it won’t cause you any loss.
Firms depend on hedging too as a basic tool. Take the firms in the aircraft sector as an example. When oil prices rise, the firms’ financial year as a whole could be disturbed. To hedge before this occurrence, they’ll make deals to ensure a stable price for fuel. When oil prices fall, they’ll be tempted to buy more, then, more expenses. Yet, no harm will come to them in case of a high price.
Insurance is a second tool to minimize risk. It’s about us paying another party to endure any possible risk, in the meantime, we keep on hold to any possible gain. Anything can be insured virtually for a payment. Car insurance makes us relieved while using the car even if we have an accident. In the money realm, stock methods are one kind of insurance before its price when it drops too much.
Yet, insurance is not free of charge. In fact, we can specify the degree of risk for a certain situation by calculating the sheer cost that we’ll need to offer in exchange for insurance. Earthquake insurance in California, for instance, requires a higher price than it is in Tennessee.
A group of experts accuses the insurance system of encouraging people to have avoidable risks through the delusion of fake security. For instance, in the surfing realm, Jet Skis are necessary devices used as one type of insurance to save surfers from sudden wave accidents. After the sport expanded to a larger scale, people saying there are beginner surfers follow the adventure knowing that they’re not qualified enough as they guarantee their own safety bearing in mind that Jet Skis would rescue them when necessary. On the other side, giving insurance has driven skilled surfers to examine their own capabilities and build chances for progression and mastery.
Chapter 6 – It’s prominent that you keep yourself safe in front of unpredictable risks.
As we’ve seen, measuring risk includes establishing a plain aim and structuring all the possible results that we can consider to occur. Yet, what about the results we didn’t consider?
Common risk types can erupt at us if we don’t think of expected results. In plenty of cases, we can’t just guess for sure what will happen. In highly-charged, active cases, it’s simple to be overwhelmed by our feelings and let it disturb our delicately created strategy.
The military is a perfect instance of this. Very rare organizations designate more supplies for risk management than the military sector does. Yet, when you’re under attack, even the top-setted strategies can be replaced in a minute. In such cases, it’s essential to remain in adaptation to the current situation and maintain elasticity. To choose to replace strategies or keeping on the program can be the thin line between life and death, truly speaking.
We offer some advice to remember always which will let you remain as elastic as you can. First of all, be creative and think out of the box, even if your thoughts are related to your assistants. you won’t be insulted when you manage to strengthen your knowledge with modesty. And regardless of the case, be free to think of shitting the program when it needs to. This might need some modesty by yourself as well, yet, being an open-minded person is not enough for you must be courageous to proceed with it and really make an impact.
Now, more than before, it’s uncommonly prominent to ensure that we’re not turning into full dependents on technology. It looks like we’re capable to technically dominate all the features of life through our mobiles, from our financial matters to house safety. Yet, the same means can reflect negatively upon us through hackers and cyber frauds. We need to know for certain that such applied sciences devices are serving us by remaining updated on anti-systems of cyber, updating our pins periodically, and not be pacifies with a condition of yielding.
Risk management is like any field. Everybody is unpredictable and you can’t just have one plan to face any potential situation, regardless of how much you’re trying. Yet, knowledge, training, and elasticity will help you make the right choices and encounter risk with reliance.
An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk by Allison Schrager Book Review
The six basic instruments to risk management are well-preparation, recent data, variegation, hedging, insurance, and elasticity. These six notions can assist you face risk under any circumstance if it’s a fiscal strategy, enterprise tactics, or even handling your personal connections. Don’t be scared of risk. Study it and look at it as a chance to develop and succeed.
