Category: Risk

“What is Risk?”

Do we really know what risk is ?

I did my MBA from a B’School that is routinely featured in the top 20 Business Schools in the world. One of the best things I liked about my MBA is how sound they made our foundations on the subjects.

We were then in second half of my MBA program and the class was ‘Risk Management’. My professor’s first question to the class was:

“What is Risk?”

Various answers turned up:

“Higher the Risk, Higher the reward”
“Variability”
“Variance.”
“Standard Deviation”
“Beta”

We came up with numerous answers but it was obvious even to ourselves that we were lost in jargon and never had given this simple question deep thought. Our professor also indulged us, until we had exhausted all possible answers and fell silent.

Finally my professor answered,

“It is the chance of losing your capital”

Suddenly, all the superfluousness of ‘high risk high reward’ / ‘risk hai to ishq hai’ all struck us really hard. And I realised,

The biggest risk is not knowing what one is doing.

Do you really understand the instruments that you have invested in?
What are the worst case scenarios?
How realistic are they?
Does your asset allocation permit the rare yet plausible worst case scenario?
What is guaranteed ? Guaranteed by whom?
What is secured? Secured by What?

Don’t get lost in jargons. Its ok to refuse to invest in an instrument you don’t understand. In fact it’s lot better to do nothing with your money than something you don’t understand at all. It’s ok to ask a stupid question. You don’t need to trust anyone with your money.

What is your Risk Appetite?

Many Financial advisors ask such questions to their clients. But what does it really mean? Risk appetite means how much loss of capital can you digest? And most people unless faced with the event probably have no idea but would just pick whatever they think you want to hear.

Understanding of risk appetite and managing the risk is one of the most important things to be taken care of in your savings and investment choices.

Rich and the Risk – Elon Musk Vs Bill Gates

Recently Bill Gates said Bitcoin may be a suitable investment for Elon Musk but not for him.

This comment was widely misreported as Bill Gates saying he is not as rich as Elon and so can’t afford Bitcoins. Of course Elon is significantly richer, atleast as on today. But is that really what Gates meant?

My interpretation of Bill Gates statement would be his understanding of risk appetites of these two business men.

Gates and Microsoft

Bill Gates and Microsoft have been a conservative business who chose to play their strengths and stick to what they know. They have preferred being late to a proven field rather than early in an unproven one. Some of Microsoft’s best products including MS DOS, MS Excel, MS PowerPoint were all early acquisitions from tech startups and not home grown innovations. Microsoft preferred to identify, invest and acquire products rather than build them from ground up and launch. This approach has worked very well for them

Despite being in easily scalable, cashflow rich business, Bill Gates once built cash reserves that would be able to pay salaries for employees for an entire year if we no new cash flows had come in. Bill Gates did not want to take chances and gamble away what they had built so far and ensure they survived by building a sufficient buffer even as they grew big.

Elon to the moon

As against this, Elon Musk has undertaken several risky ventures and had not hesitated to invest all his money into completely unproven ventures with the hope to make a breakthrough.

Elon Musk, who was working on two unproven concepts of Tesla and SpaceX at the same time and did not have enough money to pay salary to the engineers as the month was about to be over.

These are two extremely different approaches by two people with extremely different risk appetites. But they know where they stand.

And it is in cognizance of this fact that Bill Gates mentioned why Bitcoins were not a suitable investment for him.

What is in it for you ?

Are you conservative like Bill Gates who would like to preserve and maintain what has been built over the years or are you wild like Elon – willing to trade it all for the unknown?

Where do you stand?

On a scale of 1 – 10, 1 being Bill Gates and Elon Musk, where do you think you would place yourselves? This answer will play a key role in your asset allocation and choice of investments. Embrace who you are and build for yourself a portfolio that will suit you.