Can you imagine standing on a platform 24 miles above the earth preparing to jump off? Would you be able to take that step?
I have a belief, I might be wrong, but I believe it to be true. Risk is what we don’t understand.
- The entrepreneur who re-mortgages to start a new business when he has young children and no income coming in.
- The adventurer who takes on a challenge that would leave most of us sick with fear.
- The investor who invests his savings in the stock markets when they have fallen 20% and can go lower still.
These people might be wired differently but I believe much of it is down to their knowledge and understanding of the situation.
They have assessed the risks, applied their knowledge and made an informed decision.
Risk is what is left over
As Carl Richards (@behaviourgap) says, “risk is what is left over when you have thought of everything else”. In other words, the will always be some degree of risk but there more we can minimise the uncertainty the less risky something becomes.
When I watched Felix Baumgartner free fall from the stratosphere I felt the adrenaline for him. He is probably the only person on earth who would even consider the prospect of freefalling 24 miles to earth, but he and his team would have managed the attempt to the minute detail. He stood on the platform with the New Mexico desert way below him knowing exactly what he needed to do to get to the ground safely. No doubt adrenaline was coursing through his veins but probably no more than most of us would experience standing on top of a 10m diving board.
When I talk to clients about putting some of their savings to work in the global investment markets the principle is exactly the same. It all comes down to knowledge and understanding of specific risks.
The risk averse may know that inflation is killing the purchasing power of their money and they know that ‘under the bed’ isn’t really a strategy, but they have a strong belief that the stock markets are where you go to lose your money.
Logically they may be able to tell you that people make money investing but they have entrenched views that it isn’t right for them. It might be what they have learnt from their parents, it might be what they have picked up from listening to the news during market crashes of yesteryear. They may have been burnt before and are fearful of going back in. Maybe they are holding onto a false belief that they are just unlucky.
Understanding Equals Less Risk
The gap to cross is a lack of understanding of how stock markets actually work. This is entirely understandable; we are never taught this stuff in formal education so how should people know about it? Surely it is more beneficial than Pythagoras, periglaciation or the chronology of the kings and queens of England?
When your ‘classroom’ is your parent’s post-war rationing mentality, a newsreader’s doom-laden report on the 1973 stock market crash or your self-learning with those tech stocks that became worthless in the late 90s, you are going to see the global investment markets as all risk and no reward. Understanding how savings accounts work is within most people’s grasp so they appear safe, even though inflation is the silent assassin of the financial world.
It is within the interest of the investment management industry to make it look complex, the truth though, is investing is simple when you cut out the noise. Buying shares is owning a small part of a company, from which you benefit from their future profits through the payment of dividends. If the company does well the value of the shares you own will increase due to rising demand for those shares. If the company does badly the value of the shares decline (because demand for the shares falls). They can ultimately become worthless, but that risk is managed by spreading your money across many different companies, some of which will do well, some OK and others may fail. Investment professionals call this diversification. You probably know it better as not having all your eggs in one basket.
The Other Side of Caution
There is another side to the risk aversion coin. Hubris. Or what psychologists term the Dunning Kruger effect. This is overconfidence, especially without the knowledge to support it.
As Icarus flew too close to the sun if Felix Baumgartner was arrogant enough to believe he could freefall from space with no planning and risk mitigation he is unlikely to have lived to tell the tale.
- We see it in crypto investors who follow the herd without understanding what they are investing in.
- We see it in people who believe they can time markets.
- We see it in business owners who believe one successful company means the second one will be too without going through the same market research they did the first time around.
The happy middle is those who have taken the time to understand the risks, realise which ones are real and which ones are perceived, and then do what they can to mitigate the former and reconsider the latter.
If you want to understand more about investing to broaden your knowledge I have produced a series of videos here.