Good Risk, Bad Risk
In their ISO 31000 Standard, the International Organisation for Standardisation defines risk as the effect of uncertainty on objectives. This is a useful and effective definition because it gives context to an uncertainty; the objectives.
It can also be said that risks threaten the things we value, which also provides a contextual backdrop.
If we consider the benefit of taking a risk, we can frame a risk-decision in those terms, perceived or otherwise, which is incredibly powerful and helpful for decision-making. That's how we tend look at things here at Oku Markets!
Harry Mills, Founder Oku Markets
Entrepreneurs are lauded for their calculated risk-taking and we are all aware of the balance of risk and reward. We're told to speculate to accumulate, to take the risk or lose the chance, and that the biggest risk is not taking any risk. As encouraging and motivational as that sounds, not all risks are the same, and people's perceptions of risks differ as their values, objectives, and circumstances vary.
There are of course good risks and bad risks, but these carry some subjectivity and it's important to maintain the frame of reference already discussed. Would you BASE-jump from the top of The Shard (this guy did), convert your life savings into the latest cryptocurrency, drink-drive, or quit your job to go it alone?
Options and Outcomes
When we are presented with an opportunity or a risk-based decision, it can be difficult to reach a rational and pragmatic conclusion as we can under- or over-estimate the consequences or likelihood of a negative (or positive) outcome of choosing one path over another.
Greater access to useful information should provide a better opportunity to make a better risk-based decision, but the information should be readily understandable and applicable: too much information or incomprehensible data can frustrate and confuse us!
A simple process-flow, and some questions to ask when faced with a choice are:
- What are my options?
- What are the outcomes for each option?
- How do those outcomes affect my beliefs, my objectives, and what I value?
- What are the potential downsides, the worst-case, the consequences?
- What are the potential upsides, the benefits, the best-case?
- How likely are those outcomes?
- Based on the above, is this risk acceptable to take?
Risk in Business
Clearly we must take some risk in order to grow our businesses. This could be in the form of taking on debt, hiring, R&D investment, M&A activities, and geographical expansion to name a few. But every business has risk inherent to its operations, which will need to be studied and action taken when required.
The Bank of International Settlements explain that:
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events
A useful mnemonic for how to deal with risks is the Four Ts:
The risk response will therefore range from ignoring the risk (Tolerate), mitigating the impact via preventative, detective, and corrective controls (Treat), passing the risk on to somebody else, perhaps via insurance (Transfer), or avoiding the risk by not embarking upon the exposure (Terminate).
By far the most common is to treat the risk through some mitigating action which reduces or limits the impact of the exposure.
Summary
We face opportunities and risks every day, and our attitude to risk is shaped by our experiences and by society as a whole.
Framing risk in terms of what you value and the potential benefits allows for more rational decisions to be reached, and greater access to information on potential losses (gains), probabilities, and impacts will improve risk-based decision making.
