Risk perception is perhaps the single biggest thing that stands between most people and wealth.
Think about it. How many times are you blasted with the message “RISK-FREE!” in advertising?
Because advertisers know that risk is the greatest thing that stands between a consumer and a sale- in fact, risk is the single biggest factor affecting whether we do absolutely anything at all. Your mind is subconsciously making risk assessments all the time at ultra-high speed!
Let me explain just how this happens every day…
1) “Shall I walk across the street at this point rather than the pedestrian crossing?” Risk: Getting run over probability increases but will be a quicker route to stores.
2) “Shall I buy this new brand of beans?” Risk: May not like this brand, but they could be better than my usual.
3) “Shall I drive at 40 mph in a 30 mph limit?” Risk: May get caught but probability is low as no speed cameras.
4) “Shall I ask that girl out?” Risk: May get rejected and everyone laughs at me, but she’s got great…er…personality, so could be worth it…
Shall I….Shan’t I? On and on it goes! So as you can see, you have vast experience in the field of risk analysis already; all we’re going to do this week is harness and nurture that skill to a conscious and rational level. In that cute example we also mentioned a key word: probability. This is the essence of correctly assessing a risk- i.e. the probability of being in a car crash is higher than being in a plane crash so the rational person prefers to fly. But we’ll come back to that.
In the world of advertising and promotion this natural human aversion to all risk is called ‘fear of regret’. It’s the one thing going over and over in our mind before we buy anything, and for that matter, before we assess the risk in the millions of decisions we make in our lifetime. And the older we become, the more we know about regret don’t we? This is why older people are seen as more risk averse.
Unfortunately for most, this weighing up of risk becomes paralyzing- they simply freeze-up out of fear and do nothing. How many times have you said after the event, “If only I’d…..”? And so we constantly beat ourselves up because of this fear of regret when we don’t have to.
Simply learning to rationalize risk and using fact to see the actual risk instead of the flawed perception of risk, enables us to make the best decision under the circumstances every time.
Let’s play another game. Okay, I tell you that whatever business idea you come up with and whatever investment you go for, there is absolutely no risk attached to it whatsoever.
You can invest any amount of money in the whole thing and you’ll get it all back whatever happens once you know the outcome of your decisions. No catches whatsoever. What would you do?
Clearly, if you’re sane, you would scrape together every cent you could find and borrow, re-mortgage your home, and invest in all you could. You quite literally have nothing to lose and can only gain. But unfortunately our world isn’t like that…
Everyone would take up this offer, become wealthy, give up work and live happily ever after. Surely then, this must prove my point that perceived risk is the single biggest factor in deciding whether people do anything. More importantly, it’s the single biggest factor that stops people from venturing into opportunities they might prosper from. ‘Opportunity’ is a much nicer word than ‘risk’, isn’t it?
The situations you are faced with are opportunities rather than risks- it’s just that some are poor opportunities and some are good!
If you took the other extreme and said that whatever investment you got into, it would fail and you would lose 100% of your investment, clearly no-one would venture into business and there would be no jobs as a result. Another completely hypothetical extreme just to prove a point.
The reality in our world exists in between these two extremes. The overwhelming majority of people wear a veil of confusion, and it masks their view from the facts, and replaces it with dogma and fear, being unable to separate business from personal superstition.
The very word ‘risk’ is derived from the early Italian word ‘risicare’ which means “to dare”. In other words, risk is a choice rather than a fate; the actions we dare to take are what the story of risk is all about- and that story defines the very meaning of being human.
And here is that story…
The basic roots of risk started in common gambling. In Greek mythology, three brothers- Zeus, Poseidon, and Hades- played a giant game of craps to decide who would have the heavens, the seas, or the underworld. Pontius Pilate’s soldiers cast lots for Christ’s robe as he suffered on the cross, according to legend. The Roman Emperor, Marcus Aurelius, was often accompanied by his personal croupier! Later in England, the Earl of Sandwich invented what became known as ‘the Sandwich’ so he could eat without leaving the gambling table, having one hand free to hold his cards. George Washington hosted regular games in his tent during the American Revolution, and gambling became synonymous with the ‘Wild West’ that followed.
But that’s just gambling- games of pure chance- in this area we really are talking about pure luck. But as you now know, correct risk assessment is more of a science, and the true story of risk lies with the scholars of the past.
The ancient Greeks had a word, ‘eikos’, meaning probability. The philosopher, Socrates, defined it as “Likeness to truth” or in other words, a prediction of something that was likely to happen. Advanced for their time, or what? Having said that, the ancient Greeks also sacrificed their children to make the winds favorable! We still have a long way to go…
Let’s do that then- the first millennium. Just after 1000 A.D., something terrible happened that was to change the world forever- The Crusades. As the Dark Ages gave way to the Medieval Ages about this time, much was changing, but some things hadn’t changed: European knights were still a bunch of bloodthirsty thugs who enjoyed beating the crap out of each other. But now, the Pope gave them a new enemy to focus on: Muslims. So they set forth to ‘free the Holy City of Jerusalem from the non-believers’. The retaliation soon after gave birth to the name, ‘Jihad’…
Anyway, if there was something positive to come out of this barbaric invasion and pointless clash of cultures, it was numbers- the tools of this thing called probability. The Christian invaders learned much from their enemy, the Arabs, who in turn, through their invasion of India, had become familiar with the first ever numbering system, invented by the Hindus. This transformed the world- everything from commerce, navigation, and science shot forward all due to numbers and probability. Over the next five-hundred years, the abacus was replaced and the belief in pure fate and chance was blown to bits.
Now we arrive at the period of The Renaissance- the turning point of creativity and education in history. In 1687 a man named Edward Lloyd opened a coffee house on East London’ docks. He offered insurance to people on a number of things including highway robbery, death by gin-drinking, and assurance of female chastity (hey, is that insurance product still available?) The very business that is most renowned for risk assessment was born- the insurance industry- and Lloyds Bank of London is a prominent player to this day, as you may know.
People were starting to see risk as a science now, not a gamble. In the late 1800s a man named Francis Galton proved something called ‘regression to the mean’ existed and helped in forecasting events with amazing consistency (probably THE best trading strategy in existence). A scholar named Laplace shunned the concept of luck and stated, “Present events are connected with preceding ones by a tie based upon the evident principle that a thing cannot occur without a cause that produces it.” Many other scholars including Bernoulli (the very same man that was to invent the principle that allows an aircraft to fly) and de Moivre concurred.
We now arrive at a more recent date to see this art of risk as science perfected. In 1979 two people named Kahneman and Tversky, proved the idea that risk perception is flawed, with the majority of people leading to incorrect decisions. The reason being because the overriding factor in human decision is not so much risk aversion as fear of losing, and that people respond to emotion rather than logic.
Their famous work was carried on by a man named Thaler. One of the experiments he conducted was to ask many different people two questions each (ask yourself these questions too as an experiment):
1) “How much would you be willing to pay to eliminate a one in a thousand chance of immediate death?”
2) “How much would you have to be paid to accept a one in a thousand chance of immediate death?”
The typical answer was $200 for question one and $50,000 for question two! Clearly peoples’ perception of value for the same item varies wildly.
This is the very essence of how you can become financially free. Can you see? The questions were asking the same thing but in different ways- the amounts of money given as answers should have been exactly the same! It’s just that question two sounds more alarming.
A lot of blood, toil, and trouble has occurred to bring you the fact that you can be master of your own destiny, that risk can be measured, and the results capitalized upon.
Many intelligent people gave up their lives to prove this, and they would be turning in their graves to see how things have progressed: the entire population becoming obsessed with The Lottery and other games of chance; belief in luck and fate are the realm of primitives.
The discoveries these pioneers made is fantastic news. Now we understand that we aren’t obliged to accept the spin of the roulette wheel or the cards we’re dealt- we are free- our decisions count and we can change our world. So why not start right now?