Risk Management

Risk management starts with what Jeff Bezos calls the “regret minimization framework.” Project yourself to age 80, or age 90. “Looking back on your life, you want to minimize the number of regrets you have,” he says.

A regret is different than a challenge, a mishap, a period of misery, or even a disaster. Most people can deal with all kinds of nonsense that hurts today but you may not regret tomorrow. A lot of what seems risky today you won’t even remember tomorrow.

Once you frame risk as avoiding regret, the questions becomes, “Who cares what’s hard but I can recover from? Because that’s not what I’m worried about. I’m worried about, ‘What will I regret?’”

And people can regret completely different things. So risk is never a blanket metric. What looks crazy to you might be something I’d regret if I didn’t try. People can have different risk tolerances in the same category, like volatility. But there are other categories that one person may regret that another wouldn’t even think about, like embarrassment and prestige. This is why risk can be such a heated debate, and why one person’s thoughtful decision looks crazy to someone else.

But a few regrets tend to be universal.

One is a decision that can’t easily be reversed. What you value changes over time. So long-term commitments that can’t be reneged on – concentrated illiquid assets, or debt that can’t be discharged – is a risk landmine. Stuff you can change your mind about – careers, employers, friends, liquid investments – don’t have to be long-term regrettable, even if dealing with them hurts for a while.

Another is a decision with downside so severe that it prevents eventual recovery. Getting wiped out. Getting banned. Getting convicted. Severe reputational harm. You’ll regret decisions that lead you there because their stench will stick to you long after you try to scrub them off and move on.

So risk management comes down to serially avoiding decisions that can’t easily be reversed, whose downsides will demolish you and prevent recovery.

I think that’s true for investments, business models, careers, relationships, etc.

And when you frame it like that, risk management doesn’t seem that complicated.

The first thing you have to do is value having options. I remember a driver’s ed class where the instructor said something like, “No matter where you are on the road, always have enough room to stop and a place to pull over.” It gets dangerous when you’re boxed in with limits on how you can react to something you didn’t expect. You’ll regret wanting to do something but not being able to do it.

The second is a religious appreciation for unknowns. There’s all kinds of stuff out there that you don’t know about, and stuff that doesn’t exist yet you’ll eventually learn about. Unknowns are dangerous because even if they’re small, your lack of preparedness to deal with them is like an embedded form of leverage. This is the basis for wanting options and having “an out,” even – or especially – when you don’t think you’ll need it.

Knock those two out and you’re ready to take some risk.

Good risks are those that you will both regret not taking and won’t regret if they backfire. This was Bezos’s point: He would regret not trying to build Amazon even if it failed.

This all sounds easy, up until now.

Taking good risks requires knowing both the odds of failure and how that failure will affect you afterwards. Which are difficult things to know. Often impossible. Especially because we’re likely to overestimate our personal odds of success. You have to overestimate your odds of success, or else you’d be paralyzed most of the time. Optimism is a rational form of ignorance. That’s part of what makes risk management really hard.

So the best we can do is work hard to put the odds of avoiding positive and negative regrets in your favor. But you can’t tame those odds. You can’t make them both 100%, because something with a 100% chance of success is probably so boring that you’ll eventually regret not swinging harder.

Actual risk management is understanding that even if you do everything you can to avoid regrets, you are at best dealing with odds, and all reasonable odds are less than 100. So there is a measurable chance you’ll be disappointed, no matter how hard you’ll try or how smart you are. The biggest risk – the biggest regret – happens when you ignore that reality.

Carl Richards got this right, and it’s a humbling but accurate view of the world: “Risk is what’s left over when you think you’ve thought of everything.”

Good luck. We all need it.

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