money health weekly


Understanding Risk


"Playing safe is very risky."

-Seth Godin


It's June 2010 in Las Vegas. It's 6:30 am. I'm taking a bus to Tropicana, where I'm getting picked up to go skydiving. I was out too late last night because I met up with some people from a rafting trip that finished the day before. When I get to Tropicana I meet a fellow first-time skydiver from Costa Rica. We talk a little bit and then are given waivers to read through and then sign. As I start reading my waiver I see my new friend initialing every page without reading it. I asked about it and he replied, "I want to skydive but they don't let you go unless you sign; I don't want to know what it says."

definition of risk

Risk = Something Can Go Wrong

At its core risk simply means something might go wrong. Period. You might slip on the ice getting your mail. You might get into a car crash on the way home from work. You might get injured going for a run. Your house might burn down. All of these examples are things that could potentially happen. There is a chance. That chance is called risk. 

Viewing risk as the chance that something might happen implies we can think about all the things that might happen and assign probabilities to them (that just means we know what the odds are). Some people will say that you can assign probabilities to risk, but uncertainty is something you had no idea was going to happen. Author Carl Richards defines risk as what's left over when you think you've thought of everything. That's kind of like how many use the work uncertainty. 

The bottom line is that you have an ideal path you'd like your life to follow, and the chance that something (whether you know about the risk or not) could happen to ruin your ideal path is called risk.

There are Two Dimensions to Risk

Thinking about risk should be thought of in two ways. First, how likely is it that something bad will happen? Second, if something bad happens, how bad will it be?

Likelihood: We all face the risk of getting heart disease. But it is more likely to happen to someone who eats less healthy foods and doesn't exercise as much. The consequences are the same in both cases, but it's more likely to happen to the less healthy person. 

Similarly, if you have your money invested in the stock market, there is a risk that you'll have to sell your investments after a loss. That is the consequence. However, people who have a plan in place to keep money they need out of the stock markets and understand market history are less likely to have this risk show up.

more likely is riskier