Understanding the Devil a.k.a. "Risk"
It is much more than volatility alone...
“Risk is what’s leftover when you think you’ve thought of everything.” - Carl Richards
This post has been inspired by Morgan Housel’s post published in Jan 2018. His writing is very eloquent and covers the topic of risk so beautifully. Instead of writing my own piece on the topic, I chose to take the different points from his post and lace it with my own observations and perspectives.
You will hear 2 voices here. The quoted ones will be the voice of maturity and wisdom and these are taken from Morgan’s posts. The elaborate explanation on the same will be of an aspiring Business Analyst who is trying to make sense of the world around him.
The objective of this piece is for you to get a firm grasp of the concept of risk, instead of equating volatility to risk, which is far from the truth and a myth that needs to be shrugged off.
# 1
People are masters at discounting risks that threaten the continuation of their past success. Winning feels good, but winning and then assuming you’ll keep winning indefinitely by doing what you just did is pure heaven and too hard to let go of.
I am currently reading the book ‘Bulls, Bears and Other Beasts’ by Santosh Nair. It is a fascinating read on the evolution of Indian Stock Markets and gives you an insider’s perspective on the many twists and turns that India’s Capital Markets have gone through.
There is a chapter that covers the Harshad Mehta Scam and it was crazy to read that the man had made an insane amount of money in a very short time in the markets. His 15,000 square feet house with a Mini Golf course and a Swimming Pool was already attracting a lot of attention. His fleet of international cars did not help in suppressing the envy created amongst his peers and other Industrialists.
He could have walked away with monumental gains on ACC, after the stock had risen to INR 9000+ from INR 200 in a very short time. But he chose to continue pushing the stock upward with funds that were not his. Eventually, the word got out and his scam was exposed, leading to his imprisonment for 9 years. Sadly, he passed away at the age of 47.
He had it all, and he still lost it all. As Mr. Vijay Kedia always says “It’s only Greed and Ego that makes people commit to scams. Greed to make lots of quick money and ego to beat the system and become invincible”. Both were at play in this case, that too on steroids.
No wonder, it’s become commonplace to hear that “Success it’s own worst enemy.”
# 2
Risk hides in the familiar and screams loudly in the unknown. Somebody somewhere is texting while driving about the risk of nuclear war.
Have you heard of stories that took a devastating turn but were completely unexpected? Some stories that have stayed with me are -
Bruce Lee dies due to an adverse reaction from a pain killer
Mr. Shrawan Kumar Choudhary dies after undergoing a 12-hour hair transplant procedure at a private clinic.
The Fukushima Daiichi nuclear disaster in 2011 in Japan was mainly caused due to the Tsunami waves sweeping over the plant's seawall and flooding the lower parts of reactors 1–4. The seawall was 7m short and the risk was highlighted in 2000 and 2008, but the study was ignored for various reasons.
COVID is another example of risk hiding in the familiar i.e. People traveling, having physical contact, breathing in central air conditioning systems, and touching one’s eyes/nose/mouth without proper sanitization. This became the breeding ground for the pandemic and it spread worldwide at a rapid pace. It was impossible to predict the economic collapse in advance and take necessary precautions.
The most useful lesson from the COVID crisis is that risks could emerge from the most unexpected places and hence one can create enough buffer (financially/systemic) that could help in dealing with the crisis. Having cash in the portfolio pulls your returns down, but it gives you the freedom to make choices when you need it the most. Unlike Investors who have to sell their holdings in the worst time in the market since they did not have enough cash buffer when needed.
Since these risks emerge from time to time, it would also help in not paying much attention to forecasts as no one knows much. Even the Company’s Founders/Directors may not know the future of the company with absolute certainty. Everyone is winging it and taking it one step at a time. Economists or TV Anchors are the worst of the lot i.e. oozing in confidence about their predictions and leaving no room for surprises. Following these pundits blindly is a recipe for disaster.
# 3
Risk is everything that lives outside your ability to endure nonsense, hassle, delay, embarrassment, and setback. All are unavoidable realities of life, so it’s often better to increase your ability to endure than attempt to avoid all trouble.
If you can endure the consequences, then you have accepted the adverse situation ahead and prepared accordingly. This ain’t the kind of risk that will impair you in any significant way. This is kind of an iteration that your playing with to see what works and what doesn’t. It’s a small price to pay for the greater good.
It reminds me of the cold calls I used to do during my Citibank days. I was prepared for the rejections as I had been warned of the dismal conversion rates for these calls. I had set my expectations so low that even if I could generate 1 meeting after 50+ calls, I was happy to have produced a result since the average was 1 meeting in 100+ calls.
But if I was banking only on one particular friend to help me out in securing the job I recently interviewed for or with some loan to tide over the short-term cash situation or to give me a business deal, then I may be setting myself up for disaster. In this case, I am keeping all hopes on one friend, and he could fall short of his commitment and not show up at all. I have seen this umpteen times and it has damaged people’s morales since they couldn’t recover from the setback and eventually, land up carrying that grudge for a long time, which affects other relationships too.
You can choose to increase your ability to endure the nonsense, hassles, delays, embarrassment, and setbacks that will come, irrespective of your chosen endeavors. Or you could walk away from it and choose to play games that ain’t exciting or stimulating enough. You can’t have your cake and eat it too.
# 4
Risk has two parts: How hard it hits and how long it lasts. In anything that compounds, a small hit that lasts a long time is easy to ignore but devastating to results.
Amazon’s Fire Phone was an absolute failure but Jeff Bezos was very candid when he said “If you think that’s a big failure, we’re working on much bigger failures right now. I am not kidding. Some of them are going to make the Fire Phone look like a tiny little blip.” For him, these are plain experiments. They don’t cost him much money or reputation to try them out. It in fact created a cult following from certain shareholders who respected Amazon’s ability to endure losses in the short term while they pursued bigger games for the infinite future. AWS was an outcome of this mindset and it has transformed the P&L of Amazon. Tomorrow, it could be another innovation that is being worked upon by someone in the corners of Amazon worldwide.
The above example was about a small hit, that lasts for a very short time. But if you incur losses that lead to permanent ruin of capital or reputation, then it becomes difficult to bounce back from it.
Arthur Andersen LLP was part of the Big 5 of Auditing, Tax & Consulting services globally. Others being E&Y, PWC, KPMG & Deloitte Touche Tomatsu. It used to be one of the largest multinational businesses in 2001. But their failure in auditing the books of Enron caused reputational damage so severe, they couldn’t ever recover from it and eventually surrendered their license to practice.
Every decision a company makes, there is risk involved. What matters is how hard it hits and how long it lasts. But if the damage is one-off or the effect is only for the short term, then it makes a case for investing in those firms that can endure the consequences of risks comfortably.
The same applies to you personally. Every decision you take is a risk i.e. it may pay off or it may not. E.g. you may get accepted in a new role abroad. But saying YES to the opportunity means saying NO to being with friends, in your own city, with your family, and in a set routine. This brings a lot of variables that you can only hope for falling into place. It may, it may not. It’ll come down to you being able to gauge the hit you are taking and how long would it last or would it impair your finances or lifestyle significantly.
In summary, “Lose little, Keep moving fast. Lose a lot, you lose the ability to move.”
# 5
Risk has two stages: First, when it actually hits us. Then, when its scars influence our subsequent decisions. The crash, and the lingering pessimism that does as much damage.
If you look at the journey of Clubhouse or Angry Birds, you will be surprised to read the no. of failed attempts that were made before they hit upon a goldmine of a business. Rovio Corp. had created 50 odd games that had failed commercially. If I remember correctly, Angry Birds was the 52nd game and became a massive hit. It eventually was sold to Disney for USD 2 billion.
Even Clubhouse founders, Paul Davison and Rohan Seth, had tried building 9 different businesses but none worked out. Clubhouse was the 10th attempt and was launched very successfully and was recently valued at USD 4 billion + with Oprah, Elon Musk, and Mark Zuckerberg using it very often.
These entrepreneurs went all in, but not in a way that will impair them to financial ruin. It wasn’t taken to an extreme wherein they were left with no food and money for daily survival. Nor were they clinging onto 100% safety and risk avoidance of any kind. You can’t go all-in nor should you avoid risk 100%. The major payoffs happen when it’s a mixture of both, which allows enough room to survive while you experiment with various iterations and reap the rewards eventually.
Next time when you see a company diversifying or making brownfield/greenfield expansions, it might just be an experiment in the making, with multi-million or multi-billion dollar payoffs in the future. You could choose to invest in these and take a shot at compounding your capital handsomely.
I recently attended a Twitter Spaces session with Becky Quick from CNBC, Ned Segal (Twitter CFO), Kayvon Beykpour (Twitter Product Head) & Sarah Rosen (Head of US Entertainment & News Partnerships at Twitter). It was a thoughtful discussion on what Twitter is working on currently. They have many features in the offing e.g. Ticketed Spaces, Superfollowers and Tip Jar.
Twitter is sitting on 200 million + Daily Active Users and remains the least monetized of the social media lot. Twitter has struggled for years in getting the product mix and revenue generation strategies in place. Finally, the team has started experimenting aggressively with a lot of focus and right intention, creating the possibility of a strategy that produces the results. And if that happens, Twitter could see a massive jump in Revenues and Profits in the years ahead. (Disclaimer - I own the stock)
Twitter may have been scarred with wrong decisions and failed attempts, but it did not impact their ability and drive to innovate and experiment. They also chose a mix of going all in and risk avoidance, till they get it tight. We, as individuals, got to do the same. That’s the sweet spot where you will find gold.
Fail a lot. Fail Fast. Fail Forward.
Every experiment can make you better, opening doors for new lessons and new collaborations. Compounding this ability to take the mini blows and keep going on can add up to something extraordinary.
# 6
Risk’s greatest fuels are leverage, overconfidence, ego, and impatience. Its greatest enemies are having options, humility, and other people’s trust.
Intel’s Andy Grove would always prescribe paranoia—a suspicion that the world is changing against you. Michael Moritz, the billionaire head of Sequoia Capital, once shared that fear of being out of business is what fuelled their success.
Jesse Livermore (one of the best stock pickers) reflected:
“I sometimes think that no price is too high for a speculator to pay to learn that which will keep him from getting the swelled head. A great many smashes by brilliant men can be traced directly to the swelled head. It’s an expensive disease everywhere to everybody.”
Fear, humility, frugality, simplicity, and patience are the only antidotes to leverage, overconfidence, ego, and impatience. Nothing about the former traits is sexy. These are rather boring traits but they work and will always do. The latter is about bravado, looking good, making a statement, proving a point, and feeling invincible. Harshad Mehta episode may have ended in 1992 but there are many worldwide playing the same games even today, guided by greed and ego.
# 7
Asking what the biggest risks are is like asking what you expect to be surprised about. If you knew what the biggest risk was you would do something about it, and doing something about it makes it less risky. What your imagination can’t fathom is the dangerous stuff, and it’s why risk will never be mastered.
You are always exposed to something you haven’t planned or prepared for. Hence insurance helps against loss of death, loss of physical abilities, loss from theft, and sometimes loss of income. Cash position in the personal portfolio helps against crises like COVID, 2008 Crash, Lockdowns, and other left tail risks.
Being a person with character, integrity, professionalism, and knowledge also goes a long way in creating serendipity. There are always opportunities and if you did make a mark on someone with your demeanor, you will be picked up for the role over 1000 other people, only because you impressed your set of values upon someone, whom you didn’t even know was to become instrumental in your future endeavors.
Since you don’t know who could come in handy with a reference or a personal recommendation, how about carrying yourself well with everyone you meet? How about being sharp and well-dressed always? How about investing time in upgrading your skills and knowledge since you don’t know where it will get utilized? How about being nice to others?
# 8
Risk is as open-minded as they come. It doesn’t care where you went to school, who you voted for, what your goals are, or how you expect the world to work. It also doesn’t read history books or watch the news. It only knows that all good things tend to not go on forever without interruption.
Risk could hit you for no fault of yours. You may pay a heavy price for not doing anything wrong. You could get extremely unlucky and lose a fortune, a relationship, or a career. That’s life and it isn’t fair. It is what it is.
If you have prepared yourself to take on the various blows that life will bring to you, you will be able to keep moving. That’s what matters finally, the ability to keep moving. Nothing lasts forever, so learn from episodes that are challenging in nature or make the most of them and profit handsomely.
Either Learn or Earn, there ain’t any other option to choose from.
# 9
Risk is hard to define, and means different things to different people. To me, it’s anything that prevents you from doing what you want in the future that could be avoided with an action today.
I had a very interesting conversation with a friend yesterday. It was all about being oriented towards goals that excite you. If you calibrate your goals properly, then you will never run out of steam while pursuing them. It cannot be what someone else values, it cannot be someone else’s game. It has to be your own game where winning matters to you.
Without that clarity, you will constantly seek motivation, reasons not to work, excuses to crib, and people to gossip with. This not only sucks your energy but also creates an impression about you that won’t feed your future. Sometimes, it just takes one person to take a disliking to you for your future to be impaired.
Why risk becoming a person that digs a hole for himself. And if this makes sense, I would highly encourage you to journal your goals on a daily basis. The first activity of mine daily is writing down my goals for the next 1-3-5 years. I do this activity daily since it gives me a strong purpose to make today productive. I don’t need to listen to a peppy no. or some inspiring talk to do my daily routine starting at 4 am. It happens purely out of my goals pulling me towards them, daily.
It is incredible what clarity of your goals can do. Once that step is complete, only then can you get a sense of what needs to be avoided at all costs in the future and what work is needed today. Without fear of that probable certain future that you are walking towards, no change is possible today.
I aspire to live till 100+, hale and hearty. I want to visit 150+ countries, trek to the base camp of Mount Everest, learn Salsa, play Handpan, attend Biohacking conventions in the USA, attend live Snooker Championships in Scotland, invest in startups in India & M.E., run a successful podcast on Investing and there are many more. These will only happen if they matter to me and if I don’t mess up the next 24 hours. It’s simple and it works for me.
RISK - Only a thoughtful person can organize himself to understand the meaning of this word. Becoming thoughtful begins with taking time out and thinking hard about the choices at hand, pros, and cons for it, journalling it, and making choices with enough preparation. You can’t avoid taking risks, but you can profit from them once you learn to embrace them.
“Risk is what’s leftover when you think you’ve thought of everything.” - Carl Richards
Sources of Inspiration -
Morgan Housel writings - here, here, here, and here
Recommendations of the Week -
Ryan Holiday’s post on Trade-Offs
Mark Zuckerberg’s interview by Verge Magazine wherein he discusses the future he is building. This was a fascinating read.
An inspiring and insightful presentation on Culture by Peter Kaufman