Risk

Julia · 25 January 2012

As a result of some comments on another thread about how people perceived or failed to perceive risk, I'd be interested in members' attitude to risk.

One aspect I've been thinking about is whether appetite for risk is essentially a characteristic of personality? e.g. is the person who will drive through a flooded creek, taking the gamble of not getting washed away, also likely to take a similarly cavalier attitude to risk where money is concerned?

Or is risk in financial matters very specific, in that someone could be quite conservative in their everyday lives, yet unable to correctly evaluate the level of risk in e.g. mortgaging the family home to buy into the share market, especially if the investor is retired or close to retirement. We have seen examples of where this occurred and was followed by further gearing into the market via a margin loan on the shares purchased from the home loan.

I acknowledge that personally I'm risk averse and regard as my first priority always the protection and security of my existing assets, so perhaps my view that the above is an incredibly high risk strategy is coloured by my own bias.

What is your position on how much risk you are comfortable with? Does this change with your circumstances, e.g. earning capacity and age/years to retirement?

As an adjunct to the above, the following is an extract from a post by doobsy (thank you, doobsy) which has some at least oblique connection.

Borrowing - Australians still believe that banks are their friends and that debt is not a problem. Right or wrong we love bricks and mortar and believe it is safe. As the US, Spain etc are finding out, property is just another asset class that can have it's ups and downs. If a bank can see property prices heading south and I walk in wanting to borrow money to buy a property - is it their responsibility to tell me to come back in 6 months becuase prices will be cheaper and I won't have to borrow as much? Their first responsibility is to their shareholders to make money. #1. To not do so could get them sent to jail. Consumer protection is not their responsibility. The Govt has set rules on this and if they play by the rules then I don't see the drama. If they break the rules then watchout.

A second part of this is borrowing for other purposes. How many people borrowed to invest in Gold Coast units or worse listened to a spruiker and pulled their super out to buy 2 units, or to start up a small restaurant business in Brisbane only to see GC units fall in value by 25% or Brisbane get flooded and have lost their capital. Where is their bailout?

I do not want to focus on the specifics of the above, rather the overall subject of how we perceive risk.

robusta · 25 January 2012

Good thread Julia.

Many people IMO only see risk as a negative but when you think about it there is no reward without taking on some risk - the trick is to be adequately compensated for the risk taken.

Bill M · 25 January 2012

Risk is part of our everyday lives. From the moment I step out the door of my house I have to assess whether it will rain or not and whether I need to take an umbrella or not and as such I then have to risk assess everyday activities. Even to this day I still get that simple little thing wrong from time to time.

In my normal life outside of investing I take more risks than what I would for my investments. For example I have no fear in renting motorcycles in Asia and riding them around busy streets, mostly because I know I can do it well and I enjoy it. I love to travel the globe using very interesting modes of transport that can be life threatening.

On the other hand I am retired and I have to be careful how I manage my money, otherwise I might have to go back to work if I stuff that up. I would NEVER mortgage my house to try and make extra $$$ on top of what I have already (I have made a rule that that is a no go zone). Reason being is if I make a wrong decision I don't want to lose my house.

Having said that I still take risks with my money all the time. I invest in stocks, hybrids and investment property only because if I didn't my money wouldn't grow and I wouldn't keep up with inflation. On the other hand, if I had enough capital to put it in the bank and just live off the interest and have it grow each year then I wouldn't risk my capital elsewhere. Or to simplify, if I had more than enough then I would not need to or want to invest in anything other than 100% Government Guaranteed term deposits or other similar safe investments.

Edit: I should add that when I was younger I had 2 investment properties which were mortgaged. I took on huge risk because I knew I could (financially with 2 jobs). At that time I had the ability to work my way out of difficulty if the situation should have arisen, it didn't. As a consequence on taking on that risk I am now retired, it was a good risk/decision at the time, cheers.

Tysonboss1 · 25 January 2012

robusta said:
Good thread Julia.

Many people IMO only see risk as a negative but when you think about it there is no reward without taking on some risk - the trick is to be adequately compensated for the risk taken.

Thats one point that is often brought up by different people.

Risk vs Reward.

Depending on how that is interpretated, It may give the impression that very large risks are good so long as there is a chance of a very large return.

But in my opinion, If the risk is a complete loss of my life savings, then that chance of getting a really high return means nothing to me. The risk is simply to high no matter what the promised return is.

Another interpretation is that High returns must automatically be high risk, this again is not completely true just as high risk does not gurantee high returns.

Tysonboss1 · 25 January 2012

Bill M said:
For example I have no fear in renting motorcycles in Asia and riding them around busy streets, mostly because I know I can do it well and I enjoy it. I love to travel the globe using very interesting modes of transport that can be life threatening.

.

No doubt, you probably hedge out some of those risks ( I hope) that would be to big to absorb by having some travel and medical insurance, and by hopefully wearing a helmet.

Your comments also spark the questions of knowledge and skill.

No doubt your skill level when it comes to riding a motobike would mean you were taking less risk than I would be if I attempt the same thing following you down the road, So in my case a larger degree of conservatism and safty gear would be required.

Bill M · 25 January 2012

Tysonboss1 said:
No doubt, you probably hedge out some of those risks ( I hope) that would be to big to absorb by having some travel and medical insurance, and by hopefully wearing a helmet.

Yeah I do both, plus I even have a license in one of the countries to make sure the insurance pays out just in case.

Garpal Gumnut · 25 January 2012

Julia said:
As a result of some comments on another thread about how people perceived or failed to perceive risk, I'd be interested in members' attitude to risk.

One aspect I've been thinking about is whether appetite for risk is essentially a characteristic of personality? e.g. is the person who will drive through a flooded creek, taking the gamble of not getting washed away, also likely to take a similarly cavalier attitude to risk where money is concerned?

Or is risk in financial matters very specific, in that someone could be quite conservative in their everyday lives, yet unable to correctly evaluate the level of risk in e.g. mortgaging the family home to buy into the share market, especially if the investor is retired or close to retirement. We have seen examples of where this occurred and was followed by further gearing into the market via a margin loan on the shares purchased from the home loan.

I acknowledge that personally I'm risk averse and regard as my first priority always the protection and security of my existing assets, so perhaps my view that the above is an incredibly high risk strategy is coloured by my own bias.

What is your position on how much risk you are comfortable with? Does this change with your circumstances, e.g. earning capacity and age/years to retirement?

As an adjunct to the above, the following is an extract from a post by doobsy (thank you, doobsy) which has some at least oblique connection.

I do not want to focus on the specifics of the above, rather the overall subject of how we perceive risk.

Thanks Julia,

I will enjoy this thread, good on you for starting it.

For the mathematically inclined, Laplace, the great French mathematician is a good person to google on the estimation of risk.

gg

Calliope · 25 January 2012

Risk is not taking out insurance.

tech/a · 25 January 2012

Risk is my favourite topic.

It will take me longer than I have time for to answer in depth so ill bullet point for my own case.

(1) Needs to be quantified before accepting.

(2) Needs to be controlled as best you can---dont take on risk you have no control over where possible. EG trusting your funds with someone else who makes the decisions.
Like a Building development.---if its YOUR building development then fine you can quantify risk. you cant quantify a third party---refer Storm thread.

(3) Understand your capacity to accept risk.

(4) Only take leveraged risk when the risk is basically zero. IE in the latest housing boom in 1996 to 2001 you could buy on 10% down and rent would cover all out goings and interest.---Leverage yourself as much as you can. Today totally different---the risks have changed.

(5) Can the Risk be negated---in time--if yes then negate the risk as soon as possible.
If not hold until the reward is no longer equal to the risk.---I've sold portfolio's in 2008
and properties in 2005 to now--deleting risk in the first instance and mitigating risk in the second instance.

(6) Not all risk is acceptable.

(7) Financially income streams can be the biggest mitigation of Risk. As Bill says continuous income is powerful.

(8) Always analyse risk where it will impact your life. Plan your strategy!!

(9) If you take on a RISK and an OUTLIER event will wipe you out---the risk is too great.

tech/a · 25 January 2012

Calliope said:
Risk is not taking out insurance.

More to the point---reading the fine print---more again---understanding what the fine print is saying!

Did you know that if someone lights up your house in malice--Arson----chances are YOUR NOT COVERED---check your policy.

Wysiwyg · 25 January 2012

e.g. is the person who will drive through a flooded creek, taking the gamble of not getting washed away, also likely to take a similarly cavalier attitude to risk where money is concerned?

Well I would not cross a flooded creek but I would go all in on what is a good prospective share. Reason being that if I crossed the creek I could get washed away and die whereas losing a wad of money on 'what was' a prospective share, is replaceable.

There is certainly greater risk financially when other people are involved. When other people determine the outcome.

basilio · 25 January 2012

Good thread Julia.

I'm not sure how easy it is to accurately assess risk in many investment situations. In fact a strong case could be made that many of the most highly promoted investments have the most dangerous risks (and often fail) and yet the stories told to investors to ally their fears are dishonest.

Some specific examples come to mind

1) The many investment groups that promised people their money was going into bricks and morter first mortgage property investment when in fact it was holes in the ground speculation

2) Overpriced interstate rental investments sold by property developers.

3) Most of the financial advice industry that takes its money from flogging the deals with the most commission as well as adding their own charges to the list.

I also find it a challenge to balance the risks of individual investment decisions against the overall economic background. For example a particular company might seem quite an exciting and potentially profitable investment. But if the overall economic situation becomes extremely unstable it's likely that even these will be severely affected.

Julia · 25 January 2012

Many thanks for interesting and thoughtful responses - much appreciated, folks.

Bill M said:
In my normal life outside of investing I take more risks than what I would for my investments. For example I have no fear in renting motorcycles in Asia and riding them around busy streets, mostly because I know I can do it well and I enjoy it. I love to travel the globe using very interesting modes of transport that can be life threatening.

On the other hand I am retired and I have to be careful how I manage my money, otherwise I might have to go back to work if I stuff that up. I would NEVER mortgage my house to try and make extra $$$ on top of what I have already (I have made a rule that that is a no go zone). Reason being is if I make a wrong decision I don't want to lose my house.

OK, so you clearly distinguish between calculated physical risk and the potential risk of loss of your existing financial security.

Having said that I still take risks with my money all the time. I invest in stocks, hybrids and investment property only because if I didn't my money wouldn't grow and I wouldn't keep up with inflation.

Here you're presumably investing capital deemed for that purpose rather than e.g. gearing existing assets to buy into stocks etc.

On the other hand, if I had enough capital to put it in the bank and just live off the interest and have it grow each year then I wouldn't risk my capital elsewhere. Or to simplify, if I had more than enough then I would not need to or want to invest in anything other than 100% Government Guaranteed term deposits or other similar safe investments.

Edit: I should add that when I was younger I had 2 investment properties which were mortgaged. I took on huge risk because I knew I could (financially with 2 jobs). At that time I had the ability to work my way out of difficulty if the situation should have arisen, it didn't. As a consequence on taking on that risk I am now retired, it was a good risk/decision at the time, cheers.

So Bill, you've clearly outlined a differing capacity for risk at different times of your life e.g. the investment mortgages which you knew you could service at the time, whereas you'd probably be very unlikely to do that now.

tech/a said:
Risk is my favourite topic.

Good. Mine also.

(3) Understand your capacity to accept risk.

This one is always interesting. I suspect this is poorly understood by many.
It probably also needs to include the capacity to understand the level of risk.

(9) If you take on a RISK and an OUTLIER event will wipe you out---the risk is too great.

Ah, I hoped someone would come up with this.

basilio said:
3) Most of the financial advice industry that takes its money from flogging the deals with the most commission as well as adding their own charges to the list.

True. Do you think there will be any genuine improvement in this as a result of the changes to the industry currently proposed?

I also find it a challenge to balance the risks of individual investment decisions against the overall economic background. For example a particular company might seem quite an exciting and potentially profitable investment. But if the overall economic situation becomes extremely unstable it's likely that even these will be severely affected.

I'd say the very fact that you're aware of the need to consider the wider environment suggests your decisions here will be pretty sound.

Bill M · 25 January 2012

Julia said:
Here you're presumably investing capital deemed for that purpose rather than e.g. gearing existing assets to buy into stocks etc.

Correct, I don't borrow any money for anything anymore other than on my credit card which I pay off in full every Month.

the investment mortgages which you knew you could service at the time, whereas you'd probably be very unlikely to do that now.

That's right, I just don't want to go back to work if things go wrong, so there is no way I would take on a mortgage at this time.

basilio · 25 January 2012

The topic of risk becomes murkier and murkier in my view. In my view I believe that much of our current economic and political system pointedly refuses to acknowledge quite clear risks because the consequences of having to face and deal with them are just too confronting. And that happens on a personal level as well.

On the financial front I can't recall any other time our economic systems have faced such pressure from the volume of personal, corporate and national debt. I saw an apt comment which pointed out that if a debt can't be paid it won't be paid. So when we see $15 trillion US national debts and the rest of the world in similar situations (with regards to the size of their economies) it seems impossible to address the issue. And yet this unpayable debt is the cornerstone of our financial institutions, pensionfunds and nominal personal wealth.

So I fear we just close our eyes and ignore it.

I have similar concerns with the issue of Peak Oil and the decline of energy resources. The evidence is now in that oil reserves are depleting around the world and that there is simply not sufficient new discoveries to keep production rising or even static. (See International energy Agency 2011 report) The implications of an industrial world facing a terminal energy shortage are clear. When energy supplies run down so does our whole system. How do we "quantify" that risk ? How do we act on it personally and as a society ? Or is it just too hard and too scary ?

It seems to me that many organizations and institutions are happier to develop risk strategies for the small stuff and won't touch the outliers.

http://www.worldenergyoutlook.org/docs/weo2011/executive_summary.pdf

Glen48 · 26 January 2012

Wysiwyg said:
Well I would not cross a flooded creek

What if you had to say a medical emergency , risk is doing what you think you need to at the time, I have found do it and if it didn't work it is not your fault entirely because you were using all the information you have available at the time.

tech/a · 26 January 2012

Bill M said:
Correct, I don't borrow any money for anything anymore other than on my credit card which I pay off in full every Month.

That's right, I just don't want to go back to work if things go wrong, so there is no way I would take on a mortgage at this time.

Bill
Through life you never considered creating passive income?

How do you cope with the erosion of inflation.
In 10 --- 15 yrs time the average wage will no longer be $71,000
More $120,000

odds-on · 26 January 2012

Good thread Julia.

Risk is a complicated topic which can get a bit heavy at times. If I was to simplify risk analysis to the best of my ability then I think it should always be analysed in terms of two components:-

1. Necessity. People do what is most necessary to them at any given moment.
2. Competence. Do the people involved in an activity know what they are doing?

Sometimes necessity means accepting increased risk, just as lower competence increases risk. This applies to investing, mountain climbing, Somalian pirates and so on.

Cheers

Oddson

Smurf1976 · 26 January 2012

Glen48 said:
What if you had to say a medical emergency , risk is doing what you think you need to at the time, I have found do it and if it didn't work it is not your fault entirely because you were using all the information you have available at the time.

Thus far in my life I have been faced with a few emergencies as have many, and it is truly amazing what you can / will actually do under such circumstances.

It might take half a day to clean up the yard normally and you might never consider jumping off the top of a ladder. But faced with an actual, real fire heading straight toward you then you find that half a day's work really can be done in 20 minutes of frantic running around. And if there really is an out of control truck heading toward you, well then you do just jump off the ladder and run.

Under normal circumstances I would never consider doing either of those, but faced with an actual emergency priorities do change in an instant. The risk of a broken leg beats the certainty of being run over by a truck. The risk of exhaustion and a few cuts and scratches whilst frantically clearing the yard beats the certainty of the house burning to the ground. Etc.

Julia · 26 January 2012

odds-on said:
Risk is a complicated topic which can get a bit heavy at times. If I was to simplify risk analysis to the best of my ability then I think it should always be analysed in terms of two components:-

1. Necessity. People do what is most necessary to them at any given moment.
2. Competence. Do the people involved in an activity know what they are doing?

Sometimes necessity means accepting increased risk, just as lower competence increases risk. This applies to investing, mountain climbing, Somalian pirates and so on.

Cheers

Oddson

+1.

Smurf1976 said:
Thus far in my life I have been faced with a few emergencies as have many, and it is truly amazing what you can / will actually do under such circumstances.

It might take half a day to clean up the yard normally and you might never consider jumping off the top of a ladder. But faced with an actual, real fire heading straight toward you then you find that half a day's work really can be done in 20 minutes of frantic running around. And if there really is an out of control truck heading toward you, well then you do just jump off the ladder and run.

Under normal circumstances I would never consider doing either of those, but faced with an actual emergency priorities do change in an instant. The risk of a broken leg beats the certainty of being run over by a truck. The risk of exhaustion and a few cuts and scratches whilst frantically clearing the yard beats the certainty of the house burning to the ground. Etc.

Glen48 said:
What if you had to say a medical emergency , risk is doing what you think you need to at the time, I have found do it and if it didn't work it is not your fault entirely because you were using all the information you have available at the time.

OK, good point. I should probably have excluded the need to take extraordinary risks in extraordinary situations.
We've seen good examples of the above in the World Trade Centre where people jumped rather than burned.

The flooded stream example was meant in the sense of plunging through rather than waiting a few hours for the water to recede.

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