I talk in previous articles about some of the things I learn from my time trading in the financial markets. The biggest and most important lesson I learn is how to correctly evaluate and manage risk. First I learn that you cannot succeed unless you take risks. Second, I learn that if you take too big of a risk you are eventually going to lose all of your money. (Look up a guy named Jesse Livermore, someone who makes millions of dollars during the stock market crash in 1929, but ends up losing it all later because of poor risk management, eventually committing suicide.)
After spending some time away from the markets, I eventually realize how risk management applies to other areas of our lives, and how we can use smart decision making combined with taking risks to drastically improve our chances for success, at the same time protecting ourselves from harm.
You have to take risks in order to succeed
I don’t care who you are, if you want to succeed you have to take risks.
Want to run a business and make tons of money? You have to risk that business failing and you losing time and money.
Want to become a doctor? You have to put in hundreds, if not thousands of hours of studying and hard work at the risk of not getting into the right Medical School or Residency Program.
Want to become a pro athlete? You have to risk your time, effort, slim odds and possibly injury while competing with the best in the world.
Want to date that cute girl you work with? You have to have the guts to walk up to her, make your intentions known and get her number, risking rejection in the process.
A great way to see whether a risk is worth taking is the risk/reward ratio. You obviously can’t quantify everything, but by thinking in this way you can get a feel for whether a decision is worth making or not.
Here’s an example of bad risk management:
- Risk: Potentially Killing Someone or yourself/DUI/Spend the Night in Jail/Lawyer Fees/Court Dates/Fines/Criminal Record/crashed car/probably a lot more
- Reward: You get home
This is an example of risk management gone wrong. The risk is so large and potentially so damaging to your life, why wouldn’t someone just take a taxi or Uber home and completely eliminate that risk?
Here’s another example of bad risk management:
You see a cute girl that you want to ask out but don’t because you chicken out:
- Risk: You get rejected, walk away and live the rest of your life, possibly learning something about yourself and how to improve
- Reward: She likes you, a potential healthy relationship, learning more about yourself, and you form a special bond with someone. Who knows, maybe she becomes your wife.
These are two very common examples of poor risk management that run rampant in our society today. These two occurrences literally happen hundreds, if not thousands, or tens of thousands of times every single day.
The first example is a stupid risk. By driving drunk someone is exposing themselves to such incredibly damaging risks to themselves and others that the simple reward of just getting back to their house cannot possibly justify getting in a car and driving.
The second example is a smart risk to take. At the very worst you get rejected and continue living your life. But at the best you open yourself to a huge reward via the possibility of having a friendly interaction with someone you find attractive, and possibly a long term relationship, and at the very least you can learn something from the interaction.
This is a very basic rundown of how you can use risk to move your life forward, maximizing gain while minimizing harm. The basic idea is to focus on skewed risk/reward relationships.
If the risk is high, and the reward is low, it is a bad risk.
Example: risk $10 to make $1
If the risk is low, and the reward is high, it is a good risk.
Example: risk $1 to make $10 (exception: the lottery. I read a study once stating that trying to win the lottery is the equivalent of trying to commit suicide by flying commercial.)
Not every action will work out however, and I’m sure some people can find situations where the numbers work out differently, especially in low margin businesses, etc. But this is meant to be a general guideline to point out the more obvious instances in your life where you might be unknowingly and unnecessarily exposing yourself to large risks with small rewards, and shying away from large rewards with low risk.
I highly recommend implementing this, it will absolutely change your life once you see the benefits to smart risk taking.