We take risks all the time. Whether we sprint across the street when the light has already changed; wonder if the dog really came in before we left the house for the day; hurl an insult about our boss to a work friend without checking if that boss is within earshot; and say yes to a particularly convincing relative who needs funding for her new venture. Most of the time, we only fleetingly recognize how much we might be risking, from our life or Barney the dog's sanity, to our hard-earned savings.
My colleague Karen Firestone is CEO and President of Aureus Asset Management, a Boston-based investment firm that provides contemporary asset management to families and individuals. I recently asked Karen about the best way to take smart risks-the ones that will move you toward your goal without causing too much damage if for some reason they don't work in your favor. If anyone knows about how to take smart risks--in business, investing, and life--Karen does.
The words that follow are all hers.
As a professional investor, I understand the risk-taking that accompanies my line of work, but I pay attention to all the other risks, large and small, that face me, my colleagues, and family in the course of our multifaceted lives. My book, Even the Odds: Sensible Risk Taking, in Business, Investing and Life, outlines the four tenets of sensible risk taking and how we can apply them to our own situations. They are:
- Right sizing
- Right timing
- Relying on knowledge and experience
- Maintaining skepticism about predictions and promises.
Applying these principles to evaluate and assess our risk taking can add a beneficial dimension to our decision making process.
Right sizing is often the place to start when we begin to think about a new enterprise, changing jobs, making an investment or even expanding relationships. How big is too big, how much money is the right amount, and how far a distance to a new factory are all examples of right sizing.
Can we really afford the investment we need to make in the startup and if not, who will fund it? Is the acquisition of a competitor an appropriate size for our company? If not, it might swallow all of our resources or energy, and overwhelm us before we can integrate and benefit from the purchase.
Will the next job we are contemplating vault us to the next level at either a meaningful upside in earnings or at least that potential upside before too long? With investments, professionals should consider the size of positions carefully, to determine the range of impacts on a portfolio. It makes no sense to invest a tiny amount in the best idea you have come across in years, but likewise, oversized weights that go bad can destroy a fund's performance for a year or longer.
Buying a house is an exercise in right sizing that affects almost all of us sometime in our life. We need to consider the actual amount of space that we need and the amount of money we can spend without putting pressure on our lifestyle.
Right timing is a necessary element in most risk-taking efforts. Fashion houses, boat and auto makers, hotels, and many other businesses think about timing on a chronic basis. Opening an ice cream shop in December would be an unnecessary timing risk. When we have an interesting job offer, it would be imprudent to tell the firm that you need another month or two to think about it, unless you are willing to risk losing the position.
Relying on knowledge and experience is a critical element in assessing risk. It makes no sense to take a risk unless we have some underlying knowledge that helps in that effort or assists us when making a decision. When evaluating a new product line that you may consider developing to offer customers--whether you are a restaurant adding a menu item, a mutual fund company expanding its suite of available funds, or a software firm moving into security products to complement its other lines--we need to have deep understanding of the move being considered. This involves studying the project before making any choices then placing the right individuals, with the proper skills, in charge of that pursuit. No one wants to take the chance on a risky orthopedic procedure unless our surgeon has performed the operation successfully many times. As a doctor once told me, "If you're asking if I need a manual, the answer is no, not at all."
Maintaining skepticism about predictions and promises is your best friend when assessing risk. Failing to do so is the great downfall in risk taking. A friend of mine was inexplicably convinced by a doomsday-invoking "economist" to cash in his retirement funds and invest the entire proceeds in gold. Not only was the move totally illogical, but it turned out to be near the peak price of the commodity.
When we hear a pitch about a stock that is absolutely "guaranteed" to be a rocket ship, it is a sure sign to watch out. "The best idea I ever heard" is the epithet on thousands of tombstones across the start-up cemetery landscape. The clean black-and-white rows and columns on a financial spreadsheet are very disarming because they always suggest certainty, but projections are someone's best guess, however much work went into those assumptions.
The four tenets of sensible risk-taking offer us additional tools in considering how to address the risks that confront us throughout our business, investing and personal lives. These apply whether we are contemplating those risks that are large and obviously significant or those that seem, on the surface, to be small or mundane. The benefits can be your job, your dog's well-being, your hard-earned assets--or even your life.