In a recent CNN Money Blog by Walter Updegrave (Why there’s no such thing as risk-free investing) he explores how even the most conservative of investing strategies has risk associated with it. He makes the following points:
- all investing involves taking (on) some form of risk, even if it is not apparent;
- when avoiding one threat, you will leave yourself open to a different kind of danger;
Walter outlines what happens when you seek out and invest in the most secure of all monetary investment strategy: FDIC insured savings accounts. Assuming you stay within the FDIC insurance guidelines, no matter what happens, you will get your money back if the institution you invest it with suffers a serious setback. So where’s the risk?
The risk is in the broader investment’s environment, most notably inflation. Inflation is the process of the power of compounding. In the case of the secure investment, you will forego investment growth risks by getting a secure nominal growth rate (e.g., 1%). What happens if inflation on average for the next ten years is 2%? . After 10 years you will have a growth in the nest egg of 10%. However, the 2% inflation rate will have eroded that increase within 5 years and will have left you with the equivalent of 82% purchasing power (based on the original investment amount). By any meaningful assessment you have suffered a loss in your standard of living based on purchasing power.
What Walter outlines is we can’t escape exposure to risk. At best, we can choose the form of the risk we will face.
Unlike Walter, I am not as optimistic as he is. The universe we live in is more uncertain like than risk like. Because we know a lot about any specific risk (what, whether it is random in nature, so what, meaningful sense of likelihood) we can more easily see useful mitigation strategies and put a price on them in terms of how much we will pay for them (e.g., take a lower assured interest growth rate as the price for sleeping better at night).
Uncertainty, by its very nature is one’s exposure to surprise. Why surprise? It is because we fail to fully understand one or more of the critical pieces of information (what, whether it is random in nature, so what, meaningful sense of likelihood). Loss due to fire is an example. We can envisage the event, but we usually have a less than meaningful sense of likelihood and even significance of loss. We take out insurance which covers the monetary aspects of loss, but for most of us it is the non-insurable forms of loss that we can’t fully appreciate until the event happens. Examples include loss of personal, family memories, impacts on our future quality of life, etc.
From an OD perspective, we want to call these “oh oh” circumstances risk. Why, when they most often are uncertain in nature. Does it really matter what we call them? Yes, because the strategies for preparing for them can be different. I would also suggest that calling something that is uncertain like risk like is a form of denial or self delusion. It suggests that we know more than we really do.
What is the fundamental distinct strategy difference between dealing with uncertainty versus risk? Gaining knowledge that gives us additional practical advantage if the event becomes more likely (i.e., through some form of early warning/leading indicator). Why is gaining knowledge so important? Because we hope to learn that the event is truly not random. By its nature the notion of randomness is an acknowledgement of a limit in our knowledge about something.
Take the proverbial coin toss. Surely this is a random like event? No, in any specific real life circumstance there may be any number of factors at play that make the toss less random than we might innocently think. We often say, when we don’t understand why something happens:
- it was random
- it was the fault of the gods (or god)
- we must have deserved it
Note the last two examples all suggest that it really couldn’t have been random. The gods or the cabal were punishing us, or they were operating in a whimsically cruel fashion.
In OD we often help our clients deal with business, professional and personal issues. regardless of the choices in “life” made they are wittingly/unwittingly putting themselves in harms way. Our job, is to help them make the choices that maximize the likelihood that they can realize what they aspire to AND be best positioned to deal with the uncertainties and risks that come with their choices. This means that even the what appear to be the safest of choices we do them service by helping them realize what the lurking uncertainties and risks are in these most benign of choices.