Investments  

Risk perception

This article is part of
Discretionary Fund Management - October 2014

Ask people what they consider to be the riskiest things to do, and many will put flying in a plane somewhere near the top of the list.

The truth is, however, that the number of accidents compared with the number of flights taken is minuscule.

Nevertheless, it is a fact that brings perception and reality into conflict. We perceive high risks where they are low, and low risks where they are high.

In other words, between a perceived risk and actual risk there lies quite a gulf.

The perception of risk does not take place in a vacuum, however. There are two main factors that drive how much risk we perceive in the world around us. The first is personal, the second is cultural.

The personal aspect of risk is probably most recognised through what has become known as our ‘risk profile’ and will be well known to investment advisers, but it extends beyond the world of money. Perhaps unsurprisingly, most people self-identify in the medium-risk category.

One theorist on the subject, Nassim Nicholas Taleb, counsels against defaulting to a medium-risk profile on the grounds that doing so is merely hedging your bets, or making a fudge.

He says the best approach to risk is to adopt a base load of very low risk, but to spice it up with a few very high risks at the other end.

As for the cultural aspect of risk, it is probably fair to say that as a society our sensitivity to risk has increased dramatically in the past generation.

Since the financial crisis of 2007-08, in particular, we’ve become more sensitised than ever to a set of risks at the level of what could be called national infrastructure.

Our near-paranoia about risk today seems to stem from the fact that we were caught out before.

Furthermore, many people perceive risk as something that should essentially be avoided. When someone tells us that we’re “taking a risk” by following a certain course of action, we tend to hear that we’re being reckless, that the situation is unambiguously dangerous.

Taking a risk, by definition, does not mean facing certain danger, because risk is what arises precisely where certainty is lacking.

Therefore, perhaps it is time to make a change in the opposite direction and get to know again the joy of risk. Indeed, some risks are an important part of leading a satisfying life – falling in love, for example.

The phrase is instructive: what is a ‘fall’ if not a risky activity? In love, you fall, and you fall, and you keep on falling, and if it feels in part scary, which it is – after all, you’ve given your heart away – it’s also exhilarating.

It’s exhilarating because of the risk, exhilarating because instead of bridling at the uncertainty that comes with love, instead of inserting ‘love’ on a line in your risk register and monitoring it for threatening developments, you’ve embraced it and made it your own.