As people we do not assess risk very well. Fortunately, the aviation industry learned this quickly and realised that checklists are indispensable, perhaps because a slow learning curve would sooner rather than later lead to your own demise.
I want to go out on a limb to say that if you do not follow a proper process with risk assessment you will often find yourself in a pickle. The problem is that many of the risks we take are taken almost unknowingly.
Also, more often, the risks are not linked to an active decision or action, but the lack of one (such as not exercising, not quitting smoking or not saving for retirement).
Even when we consciously make decisions, such as changing jobs, deciding on insurance, a suitable marriage dispensation, an investment or whether you should drive under the influence, we fail to properly reflect on all the possible outcomes and their impact.
The risk of actions we take now which only manifests later in our lives, is also dramatically underestimated.
Let me sketch the following example to illustrate: A 38 Special revolver holds 6 bullets. Suppose that you are a smoker and I tell you that smoking increases your chances of lung cancer by 33% and you have to choose between the following 2 options.
This is a somewhat absurd example, but the fact that the two options do not evoke nearly the same amount of fear tells us a bit more.
Although the chances are twice as high that your smoking habits, rather than one round of Russian roulette, will lead to death (although it’s somewhere in the distant future), maintaining your smoking habits feels a thousand times safer compared to putting the gun to your head.
We all do things from time to time that we know are stupid or sometimes we avoid doing certain things that we know will cost us dearly in the future.
These stupid decisions are repeated over and over again because of the absence of a negative outcome in your most recent frame of reference.
In the past you may have driven home from a party many times, knowing you are over the limit, without ever being pulled over. You may overwork yourself or eat unhealthy but have not yet had a heart attack.
However, this thinking is very dangerous, and you will do well to get a better system of decision making. What follows is hopefully an easy “process” that you can follow in decisions where there is a risk / benefit ratio.
Step 1: Forget about the benefit, concentrate on the risks
Believe me, any benefit or savings in cost or effort that you could achieve by taking risks, loses it’s relevance instantaneously the moment the negative outcome plays out.
We are also inclined to underestimate the various risks or we don’t consider all the possible unwanted outcomes.
So take your time and think carefully about what could possibly go wrong. Then assume that there may be more things that can go wrong that you cannot currently foresee.
Step 2: Take probability into account
E.g. I cannot live with the outcome of a lion devouring me while out on safari.
As long as I shut my windows and do not get out of the vehicle while watching wild animals, the likelihood that it will happen is acceptably close to zero though….so I do it.
However, the moment somebody asks me to get out of the vehicle to fix a flat tire, this probability may increase to 2% or 5%.
This, albeit a low probability coupled with the outcome (the lion eating me for lunch), simply does not make the risk worth taking.
In day to day life we see how ignoring probabilities leads to very strange behavior.
People will, for example, refuse to fly after a plane crash made headlines or avoid swimming in the sea because of their fear of sharks, but they do not think twice about crossing the street or climbing into their car (where the risk is fatality or serious injury is much higher).
Step 3: Think about the impact of a negative outcome and whether you can live with this:
If you cannot live with the outcome (death, bankruptcy, imprisonment, social degradation, etc.) and the likelihood that the negative outcome becomes a reality is not negligible (in my books anything larger than 1 in a million) then it simply isn’t worth it.
Note however that 2 people can come to different decisions about if a risk is worth taking based on their own unique circumstances, preferences or perception because of the “impact effect” (think Bill Clinton and Monica Lewinsky).
From the above it should be clear that there are certain activities that simply do not make sense because the worst possible outcome can destroy your life, the potential benefit or savings are minimal or short-lived and the likelihood of a large negative outcome is not negligible.
Good examples of this are drunk driving, fraud, tax evasion and racist statements on social media or anywhere else, just to name a few.
May you make good decisions in 2018!
Andró Griessel is a certified financial planner and the managing director of ProVérte Wealth & Risk Management.
Follow him on Twitter @Andro720911. He writes twice a month for Netwerk24.
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.