Posted in Money on December 5th, 2016
We hear the words “risk free” or “lower risk” frequently in finance, especially from financial advisers. Does risk free, or low risk, actually exist, or is this an arbitrary sales pitch that people use to lie to us? I will state before writing this article that most people – especially Americans – will not be able to grasp anything in this post and should not read further. This topic is neither easy to understand, nor is comfortable to hear. I have quickly learned in my life that most people simply want to follow orders – they don’t want to create their own orders. Therefore, to rationalize why they’re following other people’s arbitrary rules, they use and create terms like “low risk” or “risk free” when reality offers neither of those.
How long will you simple ones love your simple ways?
~ Proverbs 1:22
You will never escape risk. Suppose that I told you, “You need to get a college degree because it’s a guaranteed path to success in life” and you followed my instruction. Most of you would think I offered good advice. However, whether that’s good advice or not is completely relative to the time which I told you that advice. If I told you that advice when everyone also received that advice and followed it, the value of a degree would be significantly less because everyone else would also have a degree. At a conference I spoke at a few years ago, I asked a room of banking executives how many of them would be proud if their son became a plumber; none raised their hand. I then pointed out that I knew many plumbers who made four to five times what they all made and retired within five years of working because many of them could do weekly jobs for 5-10 hours total, earning $2000. That didn’t change their view and it highlighted my point that when people believe something is low risk, no amount of evidence to the contrary will change their mind.
Let’s look at a financial example: you’re earning 5% APR in a bank account and your financial adviser describes it as risk free. What you don’t realize is that inflation is about 4.5% that year, meaning that your real return is 0.5%. When your financial adviser says “risk free” what he means is that it is nominal risk free, or you will feel that you are taking no risk because you will see no nominal losses. In reality, you are barely breaking even because the price of goods is rising. Another financial example on the flip side of the coin is a financial adviser tells you to buy stocks to keep pace with inflation, as inflation is roaring 5-6%. You dump 80% of your money into stocks and you see it rising, but then the market drops 60% and inflation grinds to a halt. You suddenly feel the pain of loss (imagine $100,000 becoming $40,000) in addition to inflation staying next to 0. What you thought would prevent you from losing actually made you lose more. Finally, some of your friends buy stocks for pennies on the dollar and you watch as their cash that was “not keeping up with inflation” suddenly experiences multiples of 40 and 50. All decisions carry risk.
You will die. I will die. Everyone will die. The end. Often, this sentiment is used to justify absolutely stupid decisions, and this is not what I mean when I write this. You should consider this when contemplating whether to take big vs. small actions in your life. When I write that “you should only trade with money that you’re willing to lose because losses are guaranteed” this is exactly what I mean. If you can’t handle losing $100, how are you going to handle dying? You will die and so will I. That’s reality. Loss is guaranteed.
Moses never saw the Promised Land, but he still led the children of Israel there. Imagine if he did the opposite:
God: You struck the rock, man, so no Promised Land for you.
Moses: K bruh. Not leading the children of Israel then.
God: Wait, what? How are they going to get there?
Moses: Joshua, dude.
Moses would be nothing. We may think our lives won’t be “something” if we don’t get one thing or another, or see one thing or another, but we forget that we often lead without realizing it. So we never get to see space travel? Does that mean we shouldn’t work to make that world possible? I would argue that most will live lives exclusively for themselves, but people with visions often understand that we don’t see everything that we were part of creating.
Every choice you make inherently means you cannot make another choice at that given moment. If you invest all your money in US stocks for one year, that means you didn’t invest in Chinese stocks for that year. What this means is that loss is guaranteed in every action you make; success is not. If your idea failed, it didn’t only fail, but many of the other ideas you could have pursued in that same time also failed. Simply put: you’ve already lost. Now some people may find this depressing, but in reality it’s not depressing at all. Most of our best decisions happen because we failed in the same area or other similar areas, and it was those failures which strengthened us. This means that big wins will more than likely result from many losses, and we’re still guaranteed to lose the other areas of opportunity costs.
Consider same famous losers:
I fall over laughing when I hear the phrase, “We can reduce our risk by” as if you can reduce probability or manipulate it in anyway. Take any example on Earth that involves manipulating the probability of an event – such as using solar energy over petroleum for increase the probability of energy independence, but then consider that there’s numerous probabilities of the sun dying or affecting us in ways that would wipe us out, so does it really matter? We still lost. What we think you can control, we can’t. There is no “reduce risk” or “lower risk” – we are simply hoping that other probabilities remain in our favor (meaning there are too many variables beyond our control even if we isolate on probability to reduce the risk of). Everyone who says, “I can reduce the probability of [A] event by” completely assumes ceteris paribus, which doesn’t exist in reality.
“When they reckon all this up, they live quietly and keep to themselves, like a man who stands under the shelter of a wall during a driving storm of dust and hail; they see the rest of the world full of wrongdoing, and are content to keep to themselves unspotted from wickedness and wrong in this life, and finally leave it with cheerful composure and good hope.” ~ Plato, The Republic
Some readers may feel like “why bother then” if every decision carries risk and it can’t be avoided. Risk reminds us that we can only focus on what we can control in every situation, while accepting the humility that everything we do is not as significant as we’d like to believe. We can control:
You will fail, you might succeed, and you should learn.