Everyone knows what risk is. More or less. But how to differentiate and properly understand it? That’s a whole different beast. I’m here to shed some light on this subject.
How to calculate which risk to take?
I find that people tend to look at risk incorrectly. So they look at risk in the traditional sense. Which is to look at risk where you say: “Ok, the more risk I take, the more potential reward or loss I can have.” So that’s looking at it 2 Dimensionally. The more risk I take, the more volatility I have essentially. When in reality, in the real world, (out of the box – personal perception of reality), the risk is subjective to your own personal situation.
Example: An employment scenario. If you have a job where you are earning £40.000 per year and you believe that having that job is safe, because you get a paycheck at the end of each month. You believe that there is no risk. But let’s move on, one step forward from that. Let’s say you want to quit your job. So if you want to quit your job with no risk, you line up another job beforehand. As one friend of mine told me back in my early twenties – “Do not throw away your (used) shoes before you have bought a new pair.” Or you’ll hurt your feet.
So you are looking for a higher salary, at another employer and you move on to that other job by quitting your current job.
But let’s say we scrap that scenario and we say: What will happen if I just quit my job, without having anything else lined up? What’s the likelihood of ever earning more than £40.000 a year, in the future? If you consider this scenario, and you calculate upside vs downside, you begin to realise that you have much more upside and downside.
Let’s analyse the downside.
What can you possibly earn that’s less than your current income? You can find another job for £35.000 a year, or £30.000 a year, or £10.000 a year. So your downside is £0.
But the real downside, in reality, it’s very small. It’s very likely that you are going to earn around £40.000 or just less than that. Why? Because you already have the skills required to market yourself for that amount of money to any employer. That’s your mindset. So that is calculating the downside.
But how about the upside?
Your upside is actually all the money in the world. It’s infinite. Even if the mathematical probability of you earning infinity, or…all the money in the world; that’s still more than £40.000. So your downside is very small and your upside is huge.
Now, the person who has the £40.000 job to begin with, tends to anchor themselves to that belief. “I cannot possibly make £200.000 in 6 months.” That’s their paradigm. That’s their self image. And then the next step is always to take on liabilities that their salary can pay for. Like having a personal loan, having a mortgage.
That to me is more risky. You are basically tying a chain around your employment, your only source of income, and hoping everything will be safe in the future. But the future is unpredictable. You can have an idea of where the trend tends to go. But take the example of Covid. How many in the world expected this scenario to happen? It has reshaped the face of the planet, on a socio-political and economic level.
That’s why risk is subjective, and not fully 2 dimensional, in the real world. Because it’s subjective to your own perception of reality, to your own personal situation.
You feel like you’re not taking risk, but you are. Because you are taking lots and lots of liabilities. You believe that your house is an asset. But if you pay for it from your own source of income, if it doesn’t generate money at the end of the month, then it’s a liability. For you at least. Remember, you have only one income stream. Your salary. So if you lose your job, you can lose your house. The house that you’re paying mortgage for is a liability for you, while at the same time it’s an asset for the bank. Because you have contractually agreed to pay the bank a monthly fee for it. And if you fail to pay, the bank not only got your money so far, but will also end up taking your asset. Your house.
So you can’t assess risk objectively. Most people can’t look at risk objectively.
Coming back to the job scenario, it was easy to calculate upside vs downside.
Freedom is your number one asset
Time is your number one asset. Because it’s limited and it must be valued. But time equals freedom from any constraints and infrastructures that you or the social environment has set up, then freedom will allow you to be objective when you are assessing risk. Because you look at everything with clarity and you look at everything with very simple upside vs downside.
The ideal situation is not having personal liabilities and assessing risk in terms of business by trying to work towards business risk, where you have very limited downside, but huge upside. And getting yourself into that situation and repeating it over and over. Till you become wealthy.
What risks should young people be taking or looking to take
- Step outside your box and assess your current situation. If you have lots of liabilities, you need to work towards freedom.
- Achieving the first step will lead you to a point on the success scale that will allow you to assess risk objectively.
Step outside your shoes, look at your situation objectively and work towards that situation.
It’s not easy but it has to be done, if you want freedom.
Take the downside of not doing this. You will always stay in a situation where you cannot assess risk objectively.
Position yourself in scenarios all the time where you have very limited downside and business risk, but huge upside. That is calculating and managing risk.
If you understand that risk is subjective, then you can take the next step towards being objective and then getting yourself in that ideal scenario.
Steps to success:
- Calculate upside vs downside correctly
- Repeat it an infinite amount of time
If you do that well, you will become wealthy.
I hope you find this post useful. Let me know what you think in the comments below.
Enjoy life,
Ionut
No Comments
Leave a comment Cancel