Risks are everywhere and in every activity; some are small and easily overcome; others are big and need careful planning and attention to avoid or mitigate. Risk Management is a systematic effort to identify, assess and manage risk – whether business or personal
Few people have an intuitive sense of the odds of an event – so most people are poor poker players. Instantly knowing the odds of losing – and the changing odds as more cards are turned up – is a requirement for professional players.
People try to find patterns in random events, even when they should know better. The “tails” in a normal distribution really can occur; that’s the premise behind Six Sigma.
How many of your road trips do you expect to go smoothly, vs how many end up with problems!
Everyone has heard of someone killed by lightning – since it usually gets on the news – but everyone KNOWS someone who has been killed an a car wreck.
Some barriers are no barrier at all to the truly determined!
Big banks were run by the producers and traders before 2008, and they continue to be run that way now. Because – they are the ones who bring in the money! Changing that paradigm is not easy, and takes a long time even with the best intentions.
Most Importantly – pay attention, and recognize what risks there are in the situation you find yourself in.
When someone calls you on the phone to tell you that you just won a big prize, and all they need is your credit card and social security number to verify – do you immediately hang up? Of course, you do. Then you should also avoid opening email from strangers, no matter how tempting the offer appears. Real businesses that do not currently have a relationship with you do NOT send unsolicited email offering important benefits – and if you are on the Federal No Call list, they don’t call you either. They send you junk mail, which you can peruse without fear of compromising your identity.
If your stockbroker is so smart, ask him if he is putting this investment in his children’s educational fund. If not, ask why not!
Especially in making personal investment decisions, ask yourself why this one rather than something else. If you don’t know, step back and consider.
Too often the latest “hot stock” is at the peak and ripe for a correction. The average investor buys high and sells low; it works a lot better if you do the opposite.
Knowledge is the #1 tool you need.
Risk management 101
Risk Management 101What is Risk Management?Why Should You Care?What Should You be Doing?
What Is Risk?There are many, even conflicting, terms anddefinitions of Risk:danger possibility perilchance exposurejeopardy consequence hazardmenace threatgamble OPPORTUNITY
Why Should You Care?• Everyone faces risks• Risks are everywhere• Even when recognized, risks are often poorlyunderstood• Bad – even catastrophic – things happen whenRisks are not managed!
Why Are Risks Misunderstood?• We easily succumb to selective validation—thetendency to remember only positive correlations andforget the far more numerous misses.– A common ploy used by psychics (often called the JeanneDixon effect) is to make dozens of predictions to increasethe odds that one will hit. When one comes true, thepsychic counts on us to conveniently forget the 99% thatwere way off.– In investing -- and gambling -- most people remembertheir big win, and forget the many losses that more thanoffset it– Potentially bad outcomes are weighted much more heavilythan mildly bad ones – even when the likelihoods are verydifferent
Personal Risk AssessmentMile-for-mile and trip-for-trip air travel is atleast 1,000 times safer than driving …
Personal Risk Assessment 2… but an air crash seems much more likely to befatal.
Managing RisksRegardless of definitions, there are 3 agreedsteps to manage risks:1. Identify potential risks2. Assess/measure the threat3. Eliminate, mitigate, transfer or accept
Assessing Risks• Few people understand either the probabilityof an event or the consequences• So … most people either underestimate thelikelihood of improbable events …• Or they overestimate the consequences ofeveryday risks …
• Humans have a poor innate grasp of probability– For example, what are the odds of two people sharing thesame birthday in a room containing twenty three people?Many think it must be one in thirty or more. Surprisingly tomost people, it is only one in two.– Theres a 100 percent chance of an earthquake todaysomewhere in the world!
• Few understand the laws regarding truly largenumbers.– Many people believe in the Gamblers Fallacy, thinkingthat if a tossed coin ends up “tails” an inordinate numberof times in 100 trials, then “heads” is bound to come upmore often in 100 subsequent trials to “even up” the scoreand return to a 50-50 distribution.– But – the odds of tossing “tails” is still 50% each time; thecoin has no “memory” of what happened previously.• A widely accepted law of statistics states that with alarge enough sample size, even the extremely unlikelybecomes probable, and therefore any outrageousthing is bound to happen eventually – even 100“tails” in a row!
Are You Safe?Our sense of "safe" is often distorted by media coverage (or thelack of it) and distance:– The disappearance of Natalee Holloway gained worldwide attentionand caused a sharp decline in visitors to Aruba, even though it is thesafest island in the Caribbean – fewer than 1 murder annually.– Your chances of being a victim of foul play are considerably greater inLas Vegas (more than 1,000 murders annually) than Aruba, yet no oneis canceling their trip to Las Vegas because of safety.Health issues and terrorism grab the headlines but crime andaccidents pose far greater risks for travelers.– In 2003 48 people died of SARS in Toronto and all of those deaths wereconnected to hospitals. But fear caused hotel occupancy rates toplummet from 87% to 13%.– 80 people died in traffic accidents in Toronto in 2003; but, once again,no one cancelled a Toronto trip for fear of dying in a traffic accident.
Road Trip RisksWhat we think…. The usual reality..
Some Probabilities of Mortality• Die from Heart Disease 1 in 280• Die of Cancer 1 in 500• Die in Car wreck 1 in 6,000• Die by Homicide 1 in 10,000• Die of AIDS 1 in 11,000• Die of Tuberculosis 1 in 200,000• Killed by lightning 1 in 1.4 million• Killed by flood or tornado 1 in 2 million• Killed in Hurricane 1 in 6 million• Die in commercial plane crash 1 in 10 millionYou are at least 1,000 times more likely to be killed on theway to the airport than to die during the flight
The Banks Still Haven’t Figured It OutAfter the “meltdown” of 2008, a reasonable personmight assume that surviving banks and brokerageswould institute better risk management proceduresand controls. Far from it! Within the past 2 years …• UBS wrote off at least $5 Billion of losses frommortgage-related debt and derivatives after 2008• AND was stung for another $2+ Billion by a juniortrader who successfully concealed his bad tradesfor more than 2 years.
And Still Haven’t …• MF Global, the third largest commoditybroker/dealer in the U.S., filed for bankruptcyas a result of excessive bets on Euro ZoneSovereign bonds.• $593M of customer funds were apparentlyillegally co-mingled with the firm’s funds andwere officially “missing”.• The bankruptcy is expected to be the 8thlargest in U.S. history.
What Should You be Doing?Investigate!1. Read the fine print!2. Identify and accurately assess the risks incritical or stressful situations.– You are about 10,000 times more likely to haveyour car stolen, than to win a lottery
And …Be Skeptical!3. Get it in writing4. If you don’t understand an investment ortransaction, don’t make it until you do.5. Insure against catastrophe.
• Failure to understand and act appropriatelycan be very costly!• Knowledge is protection!