It’s also one of those questions that once you have determined the answer, it can make a lot of decisions that follow it so much easier because once you have definitively answered this question, you have established a simple criteria as to whether or not the investment, or activity is within your risk tolerance for it. It will be either yes or no. Decision made!
If you are into property, most of your risk decisions will be based around whether the investment in front of you is worth the relative return for the risks involved in securing the financing, and spending the time and effort in getting the property or development to where you want it, without falling foul of legislation or regulation.
Is Your Attitude to Risk Consistent?
Attitude to risk is also more fluid than you might expect. You attitude to risk is often very different when you are young and don’t know any better or have any major commitments in life, so you might take more risks. It’s small wonder why insurance premiums for younger drivers are much higher. They exhibit more risky behaviours because they have less experience, they are more prone to try and impress others, and they are less mature, often not taking into account the broader implications of short term decisions.
Attitude to risk can change according to context. You may be aggressive in your investment or business activities when you are first starting out, because you are ambitious, and ambition, sometimes leads you to focus more on acquisition than protection, however, when it comes to protecting your family, you may be much more cautious in your approach, so you may put life insurance in place or some other protection mechanism.
What Determines Your Attitude To Risk?
There are two key drivers for attitude to risk and there is also a cure if you are not sure.
The first driver is hope or expectation and the second is fear. Hope is the driver that moves you towards a better future. We all hope that an investment or activity we undertake is going to make our future condition better somehow. This may be financially, emotionally or even relating to our health. This hope and expectation drive us to try new things and take new risks.
Hope however is kept in check by fear. Fear is what gets us really thinking about what might go wrong, and what if what we are doing doesn’t turn out as we hope and we end up in a worse condition that we started with.
Then there is the balance between the two, which is basically what our attitude to risk is all about. If we are optimistic and hopeful with expectations of success, then we are more willing to take the risks on, however if we are more pessimistic and doubt whether or not things will work out the way we hope or expect, then we are more likely to err on the side of caution and pass opportunities by and in doing so, will never fulfil our potential or radically change our condition or circumstances.
So what is the cure? What is the sweet spot that will keep us engaging positively with opportunities and protect us from the potential down sides? The cure is knowledge or at least our closest approximation to what is most likely to happen in any given circumstance.
When it comes to risk there are two considerations that need to be made for any given situation after identifying what could go wrong. The first is the likelihood of it going wrong, and the second is the impact on our lives or businesses if it does go wrong.
Likelihood
Likelihood of an event occurring is about probabilities. A probabilities can be anything from 1 where an event will almost certainly occur to 0 where an event will almost certainly never occur. We can illustrate this with an example of throwing a die. There is a one in six chance that any number will land. If I wanted the number 6 to land, then the probability of this event occurring is one in six. However, the probability of it not occurring is five in one, so it is much more likely that this event will not occur than will. So what do you do?
Impact / Consequences
Well that then really depends on the second consideration which is what the real world impact or consequences would be. If for example you were taking a punt on winning £10 if your number came up by putting £10 at stake would you do it?
The chances of you losing £10 are five in six, and the chances of you winning are one in six. Based on this alone, it is probably a bet you will lose. However, the consequences of losing are that we only lose £10, which for most people is worth a bit of a punt. But what if the consequences were a lot greater? What if instead of £10 you bet your life savings in order to have a chance of doubling them. If you win, you have doubled in an instant everything you have worked your entire life to squirrel away. Just think what a difference that would make to your life?
But if you lose, and you are more likely to lose, then you have just lost everything that it has taken years to build. The consequences are pretty significant. So in the first instant, when the consequences were only £10, you might take the risk because you can handle the consequences if you lose, which is likely. But in the second instance you might not because the consequences of losing are too great.
Balancing It Out
However, is there anything you can do to change the probabilities? You could of course load the die, or you might decide that £100 is the maximum you could afford to lose after which the consequences are too much versus the potential gain you might have. This is where you have determined what your risk tolerance is for this particular proposition and now you know how you will deal with it.
Once you know your risk tolerance, you will also have really good indication as to your attitude towards your risks.
You may discover that you are carefree and very optimistic in which case you may be taking unnecessary risks and not always considered the wider ranging consequences of your actions or inactions.
You may discover that you are overly cautious and pessimistic in which case you may not be taking enough risks that will move your life and business forward in a positive direction. You are potentially overthinking the consequences and doubt your ability to deal with any challenges that might occur.
And finally, you may discover that you have a healthy attitude towards risk, recognising what an appropriate amount of risk is for each activity that you undertake, and where the risk is excessive, to take measures to reduce either its likelihood of occurring, the negative impact of its consequences or a combination of both.
Conclusion
Strategically speaking, a healthy and mature attitude towards risk and managing it will not only keep you moving in a forward direction, it will also help you protect everything you have put into place as well, without being overly cautious.
So what’s your attitude to risk?
Has your attitude to risk held you back and led you to make foolish decisions?
If you could do it all over again, what would you do differently knowing what you now know?
Leave a comment below and let me know.
