Understanding What Real Risk Is (And How to Manage It)
A lesson from the Sonoran Desert.
The Sonoran Desert is home to powerful cacti—like the Saguaro and the Cardon Gigante which are the tallest and largest cacti in North America. Did you know that the Cardon Gigante can even grow without soil on bare rock? The Cardon Gigante can withstand temperatures of up to 50°C (122 F)! On the other hand, the Saguaro flourishes during the summer due to its “thick waxy coating that waterproofs” it. All cacti are impressive. Just as the Black Spruce thrives in the tundra, these cacti thrive in the desert.
As opposed to other biomes with plenty of rainfall or mild winters, cacti had to evolve to survive under the harshest of conditions. It’s the harsh conditions that can help us understand precisely what real risk is and teach us something essential about how to manage it. Risk can be as rewarding as it can be dangerous and to learn how to effectively navigate it is perhaps the most important skill that is never taught. Risk taking has an impact on anything physical, financial, our own personal emotions, and our decision-making. It is complex, counter-intuitive, and systemic.
Understanding the modern complexities of risk is fundamentally important and managing them well even more so. Why? Because we live in the Information Era and many ideas regarding risk are spreading like wildfires. Currently, there’s a fascination with entrepreneurship and a myriad of investing “opportunities.” It has become quite the norm to communicate that to achieve anything in life you must be willing to risk or you must be willing to fail. “Fail forward!” Whatever it takes to make failure romantic. But who advises this and why? What is their context? Most importantly, we need to examine the hidden cost of taking such risks and the cost of success before we even consider managing it.
Most of what we hear are the success stories of relentless hustlers. We get to see all that they gained thanks to their grit, their risk-taking, and their courage. If they failed, we’re told they stood up and tried again. Doesn’t it sound wonderful? If you just persevere enough, you will succeed. Certainly, if you put in the work you have higher odds of achieving your goals. But what we see are the success stories of millionaire (billionaire) business owners, Olympians, famous celebrities and athletes, and achievements of these kinds. What we don’t see though is the high failure rate and their severity (effects)—especially given enough time.
The key question is: what sacrifice (if any) do these successes demand? What is the true cost of that type of success? In other words, what is the real risk involved? For every success story we see, how many failures do you think we don’t see? How many failures were terminal? When it comes to taking risk, the most significant thing you can do is to always consider survival. First and foremost, you must survive. Consider that while the Redwood tree is the tallest species in the world, the Saguaro cactus can take up to a decade to grow 1 inch in height. If the cost of any success you’re after might cost you your ability to get back on your feet, it’s not worth it. Better to grow slowly but never break. Can a Redwood tree flourish in the middle of the Sonoran Desert?
Modern advice is all about being Redwoods regardless of circumstance. We are made to believe that entrepreneurs are risk lovers and that to be a successful investor you have to risk it all, YOLO (you only live once) or you’re NGMI (never gonna make it). On the contrary, successful entrepreneurs hate risk. They obsess about survival. They are meticulous in their process and as risk-free as possible. Successful traders are extremely methodical in their set-ups and risk management. They clearly define what they can afford to lose and scrutinize precisely how their business will solve specific problems. The ability to recognize when it’s a risk-off (or risk-on) environment becomes fundamentally important. You could safely say that they’re all on team cacti when it comes to high severity risk.
Even then, most life coaches, motivational speakers, or mentors will continue to preach to take action. “Just believe,” I heard a famous CEO say. And they mean well—trying to encourage us. However, it’s irresponsible to just push people to take action and skip the costs. It definitely takes courage to start something, but that doesn’t mean you won’t lose your time or money. It is delusional to think we’re different, that we will succeed where others didn’t. The key is to define how much money, time, and effort you’re willing to risk without being wiped out. If you take care of the downside, the upside will take care of itself.
B) Hidden Risk
What are the hidden risks? They’re the unconsidered and unforeseen risks of both success and failure. What is the first thing you do when you decide to take action, start something, or risk your time and resources? You probably think: How much money will I make? What will I do with the profits? You envision how success will look like. We love to “measure” the benefits but ignore the risks altogether.
Imagine a quadrant. You have Success and Failure, their Benefits and Costs. We tend to think exclusively about the benefits of both Success and Failure, but not much else. For instance, when it comes to failure, we’re actually surprisingly optimistic about its benefits: if you fail (provided you survived) you know that you can learn from the experience, refine your methods, and become wiser. Likewise, when it comes to success we’re well aware of the benefits: we meet our goals and make money. But when it comes to considering the real risks—the costs of failure—we either underestimate them or turn a blind eye. By the same token, we ignore the costs of attaining success.
So what can we do about it? When it comes to the risks of failure, we need to define exactly how much money and time we’re willing to lose. Define a time frame and a quantity. Set a tripwire. We also need to be clear about our general well-being too. With enough effort we can plan for the pessimistic (realistic) scenarios. If failure were to happen, we’d be well prepared. However, contrary to failure, we seldom think about the risks of success. These risks tend to be hidden as most no one likes to talk about what they had to give up both to get there and when they got there. Simply put, success costs more than just effort. What do we risk by being productive and achieving success?
Take a look at the most productive people, especially the productivity gurus plunging in cold showers every morning. What can’t they afford to do? I’m not saying very productive people necessarily suffer from an unbalanced life. But by definition, being productive means you found a way to dedicate most of your time to work. In these situations, you’ll have little to no time with significant others (or to yourself). If you have kids, it means spending substantially less time with them. Relationships can suffer too as they’re no longer the priority. What other hidden risks of success can you think of? There’s definitely a risk of deteriorated health, lack of sleep, worry, etc. Here you must be very honest with yourself and be clear about what you’re willing to give up (or are giving up), if only temporarily and for how long.
To be prepared and to have a plan(s) is what will keep you in the game. This will enable you to keep making progress in the long run. We consider what could go wrong and prepare accordingly. But there’s naturally events we will not be able to foresee. Humans are terrible predictors. We all suffer from an overconfidence bias (and a plethora of biases). Can we do something about the unforeseen? About Black Swan or White Swan events?
Here we come back to the Cactus. A cactus doesn’t need to expect rain to survive. It assumes no rain. The Cardon Gigante assumes no soil. If there’s a possibility of severe risk effects, we’re best prepared by either not being exposed or assuming it’ll happen and being ready. Again, limiting downside. For example, what if the stock market crashes longer than it has historically done so? Even assets can quickly become liabilities. You must cautiously define what success means to you. Determine which risks you’re willing to be exposed to (and endure) to get there and which ones you won’t. We can’t foresee much of anything in the future, but we can be prepared by risking only what we can afford to lose.
As we’ve seen: risk is about understanding the severity of the effects, considering the hidden risks of both potential failures and success, and finally, about the probability of their occurrence. This is were we make a distinction between real risk and conventional risk. What is the difference between them? Conventional risk is how we traditionally perceive risk as the probabilities of something happening. Low risk means that the probability of harm or loss to occur is unlikely, while high risk means a negative event is likely to occur. In contrast, real risk isn’t about probabilities. It’s what you can’t predict, you can’t see, and you don’t expect. You can think of risk simply as what we don’t know and real risk as what we don’t know that we don’t know.
We talk about probabilities and possibilities as if they’re the same thing. But when it comes to risk, even a very small probability of occurrence is always possible. And real risk is always evolving to surprise us, especially as we increase the complexity of our systems. Systemic risks are hard to see. One way to avoid real risks is to avoid being exposed to them. If there is a possibility of being wiped out, you eventually will be. The best risk is the one not taken. Can we even manage real risk? We manage it by defining and setting limits on possible downside. You manage real risk with insurance and by being figuratively paranoid about protecting not only your health, your home, your car, your well-being, but your wealth too.
But what about calculated risks? Aren’t risks necessary to start my own business or invest my money? Absolutely. But only if you survive, if you consider the hidden risks, and you effectively limit the downside. Otherwise isn’t it gambling? Remember, the Saguaro can take up to a decade to grow 1 inch in height, but survives and bares fruit even in the harshest of conditions.
In conclusion, what makes risk such a tricky and eluding concept is due to our human psychology. Granted, we want to succeed, we want to go out of our comfort zones, we want to take risks, and we want to grow as a result and live a life well lived. We hold on to the idea that if we put in the effort then we should achieve all our goals. We want to believe in ourselves, be ambitious, put in the work, and then work harder. The truth is we want to be the Redwood trees! We can’t accept when and where it pays off to be a cactus. They evolved to persist and even thrive in adverse conditions. And this is the business of risk taking: surviving and capitalizing gains when and if it’s possible.
Taking action, working hard, learning skills, and growing are all beautiful things to pursue in life. And there’s an abundance of information about all of this but hardly any serious considerations about risk. Subsequently, ignoring the potential risks gets us into trouble. It’s what gets us disappointed or disillusioned with life: “why did I fail if I tried so hard?” or “I succeeded and yet I’m in a worse situation.” Failure has a spectrum. Not all failure is created equal. Risk is worth taking if the probabilities of upside are substantially higher than the downside—if and only if—the severity of the outcome is not ruin (the wrong side of the spectrum). Making money and making progress will always be more about not losing it than it is about making it. And that’s the unpopular truth you won’t hear in a culture that romanticizes successful outliers.
Juan F. Diaz
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