(Well, mostly risk)
For our readers who’d like to brush up on A(c) = -u”(c)/u’9(c) or R(c) =-cu”/(c)/u’(c) or even portfolio theory as methods of determining one’s level of risk aversion, with apologies, that’s not what we’ll be doing here. As much as we’d like to get into the numeric quanta of financial decision making, it’s almost certainly a better idea to occasionally try to get closer to the beating human heart of the matter.
Which is Risk. The sum of our fears (whether we realize it or not).
There is also an element of “return” as indicated in the title, so let’s go ahead and get that out of the way.
Return = reward (+/-) for taking investment risk.
There are multiple ways to slice and dice return, but it will always be reflective of risk, and risk is what matters, so if no one minds, let’s just go with it.
In fact, there are two much more appropriate words to tail along after Risk than “and Return.”
They are: of failure. Risk of failure.
That’s the large human truth about the short itchy word, the failure part. That feeling we probably picked up like a cold in elementary school and have been honing our aversion to ever since. As you know, there’s a well-known term that derives directly from that feeling, risk-averse, which is the yellow blinking caution light that swings above nearly every business decision made in the history of commerce.
What’s the downside?
How bad would I look?
What if it goes south?
How would it play in the market?
There are even subphyla of risk aversion, absolute risk aversion and relative risk aversion, for which there are actual equations from economists Arrow and Pratt. (See above and no, thank you.)
There’s also risk tolerance, a slightly more positive version, until we realize that it aligns a little too closely with its first cousin, pain tolerance. If you’ve ever made the high-risk business play and you’re way out on a very public limb while your decision gets bandied about in the marketplace, you’ll get a gut-punch of internal data that shows how stress and fear tolerant you are. Which is interesting if you think about it because we spend most of our lives avoiding situations where we have to be tolerant of anything. But, hey, it was your call to go for the gold, and you may be projecting teeth-gritting confidence, but you’re also probably not getting much sleep.
There’s also a lesser-known version called risk neutral, which essentially means you’ve got Spock-like control over your mind and you don’t consider the risk, only the hard, cold numbers in your bible-thick spreadsheet of possible +/- risk/return scenarios. And you’ll likely do better than your risk averse/tolerant cohort. You won’t have any fun, but you’ll probably do better.
There are, of course, schools of thought, graduate courses, books, chapters and verses on how, when and why to take various levels of risk. But somebody smart said this:
If you can take the worst, take the risk.
Translation: If you can take the public and professional failure that you may experience if you fall off that limb on which you’re out, the potential upside, the return, the reward for being able to take the pain, that’s where greatness lives — when you succeed. Not maybe world-changing greatness (OK, Gates, Jobs, et al, sure) but the feeling of private triumph to go with the industry/professional one. Which is huge. And importantly, it’s personal.
The best of us embrace failure at a cold remove, the bittersweet hard lesson. But success, especially when we’ve taken a personal risk to achieve it, is gratifying at a core level, and importantly a chance for us to underscore the things that really matter to us, and what we’re willing to risk to get them. You could call it a learnable moment.
Somebody who’s smart enough to broker binary options said of making the risky choices: The clearer you understand yourself, the clearer your decisions will become. So, you may deem yourself a risk-seeker or a risk-avoider, but the more important consideration is, why? Do you understand, at your core DNA level, what drives those decisions?
Let’s pause for a moment and circle around this “DNA level” idea. For many, the mention of anything personal (why we feel what we feel) crosses the Maginot line between what’s finite, learned in grad school and etched deeply in economic theory, to what’s shadowy, soft-edged, amorphous and human. Which is to say, the realm of instinct and impression and guessing. Which on the ledger sheet also reads: higher percentage of failure.
Statistically, OK, but what about playing a hunch, rolling the dice, swinging for the cheap seats? What about going for the big win?
Here’s where we double back and talk about return and reward. The great philosophers, who admittedly probably sucked at investing, generally were proponents of the theory that big risk is the only pathway
to happiness. T.S. Eliot, who was known to turn a phrase, said:
Only those who will risk going too far can possibly find out how far one can go.
Catchy, sure, but was T.S. Eliot ever required to adhere to policy, mandates and tight margins? Um, no. He was a poet. He wrote poems about cats, for Pete’s sake. This is not to say that one should buck your boss, but rather a gentle suggestion to try to understand the importance of your personal biases and how to spice them into your risk-taking.
And there are blueprints.
Scott Reed, Harbert alum and founder/CEO of Oakworth Capital — ranked nationally near the top in client
retention — has his own take on how his company deals with risk when investing their clients’ money. They listen to their clients.
Fine. Everybody listens to their clients, but when it comes to investment management, Oakworth has it ensconced in its core values, with feedback loops and focus groups, interacting with clients to get honest feedback, good and bad. As Reed said, “If you listen closely, you’ll get a true sense of how risk tolerant clients really are — whether they know it or not.”
An important distinction, because if you’re not in business yourself, you probably have no earthly idea how financially “risk-tolerant” you really are. Who would? Here’s who should: the team investing your money. And Oakworth’s primary businesses — banking, wealth management, and advisory services —use a keen understanding of client risk tolerance to fulfill the predictable client needs through both family and business financial life cycles.
But the why? For Reed (and many insightful CEOs) it’s the core values of the company that tend to dictate everything. Oakworth made it a part of their business model from the very beginning to be selective about the clients with whom they would work — a risky choice as opposed to blowing up the balance sheet — and their single greatest criteria for that selectivity is whether or not the core values of the potential client align with their own.
If so, then the many puzzle pieces of a comfortable investor/client relationship tend to fall into place. Scott Reed’s company has a 99.7% client retention rate. Scott Reed knows how to make his clients comfortable.
When considering the “human” side of risk-taking, Damion McIntosh, lecturer in finance at Harbert, thinks that the way we invest, the amount of risk we’re willing to take, is completely dependent on very human elements:
“Socialization is a huge factor. How we’re raised, whether with carefully thought-out contingencies or a more risk-taking household, will probably translate into how you deal with risk in your personal and professional lives. Age and gender can play roles as well. If you’re younger and male, chances are you’ll take more risk (wise or not) than if you’re female or advanced in years.”
Then there’s the wildcard called FOMO, which often plays out on social media. The buzzy acronym is short for Fear of Missing Out, which may explain some of the interesting trends toward meme stocks, NFTs, crypto, GameStop, AMC and the rest of the recent financial shenanigans that seem to have been set up by bored children, except that they’re making and burning billions. Hold my beer.
At the other extreme can be the over-educated risk-taker, where every bet is laid with iron-clad economic theory, backed by strategic contingencies and short-, medium- and long-term exit strategies. The irony is that the over-educated may do no better than the day trader who’s following his gut. He’ll never go broke, but may not ever hit one out of the park either. Which is fine, too, if he’s got a plan and the plan is working for his 401(k) and the needs of his company or family.
In the end, risk, certainly explainable by equations, graphs and charts, is also unexplainably personal, and both sides of that coin matter. So, as you turn over rocks and delve into your internal risk drivers to hopefully glean some clarity on exactly how risk-averse/tolerant/neutral you really are based on who you are and how you learned, here’s something to consider.
Numbers don’t lie. Never have and they never will. So, you can always lean on cold, hard calculus to figure risk/return analysis. But numbers alone will perhaps never get you to that moment of triumph when you swallowed hard, bet big and came out smelling like a rose.
That riverboat gamble takes a bit of the internal rogue, the belief in the gut instinct, the idea that sometimes risky business just feels right. And if you lose trying to steal home, you may end up playing for another ball club, but you’ll sure have a story to tell.