Managing Risk For Simple Folks

When you decide to setup your own business whether it’s a full-time thing, a side hustle or just a hobby, you’ve made the decision to take on some risk.

Congratulations,  I bet you never thought of it that way, so my job here is done.

Some people are comfortable with taking risk, others are entirely risk averse and then there are people like Elon Musk who seem to be willing to take on almost unpalatable levels of risk and revel in the process.

The reality is, pretty much everyone has a very different appetite for risk and your acceptable risk profile often flexes and varies depending on circumstances in your daily life.

There’s a metric fuckton (an official measurement of intangible volume) of risk management jargon in that last sentence, so let me unpack it for you.

Ok, first of all, “risk appetite”.  This is kind of like it sounds, how much risk are your willing to bite off and chew.  Elon Musk invests hundreds of millions of his own money into building rockets and electric cars and some people struggle to invest in new computers for their online business because they can’t get themselves over the risk hurdle.

The next part of the buzzword bingo is “risk profile”.  This one simply means that you take a “portfolio” style view of your risks exposure across everything that you do.

Let’s look at my Superannuation (my pension fund) by way of example.  I am still in the middle of my prime earning years, so my superannuation investment profile is heavily weighted in stocks with a minor weighting in bonds and cash equivalents.  I’m able to take on a slightly riskier position in an effort to grow my Superannuation, but when I hit say 55 and am closer to retirement, I’ll probably “flex” that mix the other way and go heavily into bonds and cash equivalents to make sure that my money is more secure.

If you have a steady job like I do and you decide to take invest in an online side hustle business, then your overall risk profile is probably pretty low because your base income is largely guaranteed.  On the other hand, if you aren’t employed and you decided to start an authority site today, then your you have a pretty significant risk profile because you’re investing in a long-term asset strategy without having a “here and now” income stream.

In essence, your risk profile takes into account your entire financial situation before taking on new risks.

Lastly, I’ve used the word “flexing” a few times.  Your risk profile is kind of dynamic based on the things that are going on in your life.  If you had invested in Bitcoin before it exploded and you thought you were sitting a big “paper” financial nut, you may have been prepared to take on some riskier new investments.

As Bitcoin has fallen quite dramatically this year, your “paper” financial nut isn’t as big as it was, so that changes your risk profile and alters your overall risk appetite because you’re don’t have the funds you previously did.

To cope with that, you’d need to “flex” your positions on things that you’re currently investing in and review anything new to accommodate your new reality.

At this point, we have a pretty simple understanding of how to manage risk and if that’s all you took away from reading this, you’d be probably better offer than you were.

But let’s take it one step further…

How do you overcome your natural tendencies and outlooks towards risk?

Some people are born risk takers – they are gamblers and optimists by nature so they’re willing to roll the dice that fortune will favour them.

Other folks are absolutely risk-averse – they are conservative and see the grey cloud in every silver lining.

Most people, with even an ounce of self-awareness, know where they fall on the spectrum between these two positions.

There are two aspects to dealing with this:

  1. Metrics – gaining access to high-quality data
  2. Be your own Devil’s Advocate

I am going to start with point #2.

Irrespective of their risk tolerance or personality type, everyone considers themselves to be realists.  Nobody thinks their perspective and point of view is nothing more than a flight of fancy based on a whim.

Reality is a myth.  Your perception of the world around you and the things happening in it are entirely unique to you and effectively you shape your own reality.

If you’re an optimist, you look at the weather report, it says there’s a 50% chance of rain and so you reckon you’ll beat the weather.  And conversely, if you’re a risk-averse conservative, you stay indoors because there’s a 50% chance of getting wet.

The best situation is to just take an umbrella.  That’s risk management.

Moving on to point one and carrying on our rain example, before you so anything, you could also just bring up the local weather app on your phone and check the radar.  You’ll see if there’s rain in the vicinity, which direction it’s heading, if it’s breaking up and the speed it’s moving at.

If you only need to walk five minutes to the bus stop to catch your bus to work and there’s a 50% chance of rain in the morning but the radar is showing nothing within 50km of you, there’s a good chance you can make it to the bus stop without getting wet.

That’s an example of making a data-driven decision.

So, let’s summarize to give you the simple folks guide to managing risk.

  1. Understand your current risk profile
  2. This will inform your risk appetite
  3. Be your own Devil’s Advocate so you temper your natural instincts
  4. Make data-driven decisions whenever possible
  5. Flex your positions to account for changes in your risk profile

Pretty simple stuff.

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