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A Better Way to Think About Risk

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Written by: Charles Goldman | AssetMark 

Since at least 2008, risk has become a dirty word – something to be avoided at all costs.

Executives are spending significant time thinking about how to avoid risk in every aspect of their business: Cyber risk. Operational risk. Financial risk. Market risk. People risk. Reputational risk. Ugh!

There’s a better way to think about and act on risk. Instead of thinking about ways to avoid risk, segmenting risk into different categories changes the way leaders think about risk from mitigation to opportunity. After all, risk is where reward comes from. To put it more bluntly, without risk there is no reward!

My framework for thinking about risk is as follows: First, embrace risk. I like taking risks when the benefits will outweigh the costs. Second, accept that some risks cannot be managed. With these, however, I try to at least understand those risks, so I can assess costs versus benefits. Third, avoid the kinds of risk where the probability of benefit is low or the impact of realizing the risk is just too great to accept. To be clear, in my mind, compliance and regulatory risk fall into my third category and should be avoided by a wide margin.

Embracing risk is hard. It isn’t in our business cultural language; and other than entrepreneurs, most people aren’t compensated for taking risk. However, almost everything good that happens comes from taking risks! New businesses, products and services, innovation, social change and personal growth all stem from people willing (and able) to take risks. Being honest about your ability to embrace risk in your specific role, and your willingness to accept the consequences of risk, takes courage! If you want to take advantage of risk, changing your mindset is the first step.

Understanding that some risks cannot be controlled is key to embracing risk. In mountaineering we refer to some risks as “objective hazard.” One example is rockfall. In the alpine (above tree line in a wild environment), rocks fall. There is nothing a climber can do about that and the mitigation one can take, like wearing a helmet, has little real mitigating value. (Disclaimer: wear a helmet for the protection it does offer; and training and skill do make a difference in the mountains as they do in most everything). So, does that mean people should not go to the mountains? No! It means that risk is inherent in the activity so making a decision about the importance of the activity relative to the risk is appropriate. Again, to embrace risk you have to accept that there is objective hazard and potential failure is worth it where the potential rewards may be great.

Of course, trying to mitigate risk is important. All too often I see people mischaracterize risk and therefore fail to understand what can and should be mitigated. Another mountaineering example may be insightful. When in the mountains, we carry extra jackets, gloves and other provisions. Why? Because weather can change quickly. Trying to mitigate the risk of bad weather is the wrong way to think about it. Rather, mitigate the risk of dying from exposure to bad weather! One is doable and the other is absurd. In business it is the same thing. For example, it is absurd to try to mitigate market risk by investing in new products, people or facilities only in the good times. No one knows when the good times will come, stay or go. But it is sensible to mitigate risk by understanding what cost levers you can pull in short, medium and sustained down market environments. Good executives know what projects they will stop, people/roles they can eliminate or facilities they can shut down. Poor executives try to time markets, or worse, simply decide not to invest thinking that is mitigation.

As leaders, our job is to foster a culture of intelligent risk taking. We need to push people, and ourselves, to embrace risk. This means we need to allow ourselves and our organizations time and space to wallow in risky ideas to search for the upside of taking risks. We need to do this before we ask how we can eliminate or mitigate the risk. Mindset matters here.

We also need to look for objective hazard. In the investment business, a common objective hazard is volatility. We have some tools to manage through volatility, but the real risk is not being invested hoping to miss volatile times. We can only mitigate volatility risk by understanding that the ride is bumpy no matter what you do, but the ride is still worth taking.

Executives must learn to embrace risk in order to benefit from the opportunities that it affords. Figuring out how to look at and think about risk is key to growing your business, and your life. Taking risk forces us out of our comfort zones, whether that involves scaling a mountain or scaling your business, but embracing risk is required if you want to succeed. Enjoy the climb!

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