How To Master Risk, From a PhD Who Studies Risk Taking
Understanding business risk is not a guarantee you won’t fail. However, not understanding risk significantly increases the chances that it will consume your venture, taking with it your potential for benefit. In any work people take on for potential gain, there is inherently risk.
However, business risk operates the same way no matter what you do. While to some that may be frightening, to entrepreneurs it means risk can be, to a large extent, mastered.
An academic, entrepreneur, and engineer three-times over, Dr. Dan Rosen has spent a lot of time thinking about risk. In a keynote address at #FFCON19, he shared his insights on the timeless cycle of risk that applied as equally to explorers in the 16th century as it does to innovators today.
Choosing risk to get reward
“Risk is a choice, not a fate,” said Rosen, opening his talk. “Humans have been dealing with risk for millennia.”
He illustrated his example with a lesson explaining the origins of the word risk. In the Middle Ages, merchants regularly sought fortunes in far-off lands. While in today’s times we’d simply hop on a plane or take the train over, even short journeys back then could be treacherous. However, the potential danger didn’t stop explorers from seeking “untold riches”. Instead, they would manage what they could and accept the reality of their journey: they would either sink and die, or be successful.
Those journeys were known as “risicare”, an old Italian phrase meaning “to dare”.
The entire premise of the word “risk” comes from being daring and taking daring action for the potential of great reward. He recommended audience members read Against the Gods: The Remarkable Story of Risk to get more insight on the historical elements of risk, as his talk moved to the present day.
The cycle of risk
Risk, as Dr. Rosen described, acts the same no matter the arena. It always follows the same pathway, meaning it can be deeply understood and, to some extent, mastered.
“People think of risk like it’s a danger or something you avoid,” said Dr. Rosen in a private interview with PulseBlueprint after his talk. “And I love the story of the word risk because I think it’s much more appropriate. Risk is something you take. It’s conscious. It’s a choice.”
During the talk and after in conversation with PulseBlueprint, Dr. Rosen outlined the 5 key elements to understanding and monitoring risk. Interestingly, only one of those steps actually involves taking risk. The rest are about self-awareness and personal comfort levels (which sounds a lot like overcoming fear and doubt, if you ask us).
Step 1: Risk tolerance and capacity
The first step to understanding risk and to know what your own tolerance and capacity is. Risk is fundamentally relative, meaning it looks better or worse depending on an individual’s circumstances.
For example, losing $1,000 dollars can objectively be looked at as a negative.
However, from a risk standpoint, it is significantly worse for someone who only had $1,000 to their name versus someone with $100,000 or $1 million.
That being said, someone’s risk tolerance may be the same no matter how much money they have. This would mean losing $1,000 would be equally devastating to the person when he or she had $100,000 as when they had $1 million.
Continuing this example, though, risk capacity is vastly different at each level. While an individual may have no risk tolerance to lose $1,000, the reality is they are far more able to when they have $1 million than when they have $100,000 or $1,000.
Figuring out risk tolerance and capacity is required before anything else because of how it interacts with the rest of the steps.
Step 2: Required risk consumption
This is where personal goals come in relative to risk. The idea of required risk consumption is based in the law that anything with potential benefit has risk. Further, there’s often a correlation where the higher the benefit, the higher the risk. So if you want huge benefits, then the required risk consumption is likely to be much higher than if you only wanted small benefits.
This is, on an oversimplified level, the difference between getting what you want and not getting what you want. If you want something badly enough, then you accept the required risk consumption and use the remaining steps to navigate and mitigate risk where you can. If your business risk tolerance is hard-wired but doesn’t cover the required risk consumption of your goals, you must change your goals.
For some, this is a freeing notion. When you alter your choices to match other priorities, in this case your risk tolerance and capacity, you can gain a sense of peace.
For others, this is a signal to change their risk tolerance or find ways to increase their risk capacity.
Combining the first two steps – risk tolerance, capacity, and required consumption – gives you a picture of your goals from a risk perspective.
Step 3: Risk policy
The idea of a risk policy is to help guide your own actions and the actions of others who do work on your behalf. Ray Dalio, founder of hedge fund Bridgewater, talked at length about getting the right kinds of actions through the right ‘policy’ foundations in his book Principles.
When creating a business risk policy, note it has to be customized to what you do. For example, Dr. Rosen’s company d1g1t is in the financial analytics and wealth management space, so risk policy would be things like the kinds of accounts and investments work for clients. In other industries, such as sports, for example, risk policy might be more focused on injury prevention and optimizing technique.
Think specifically of your goals and tolerance/capacity when creating mandates. In general, think of policies or mandates that help you:
- Capitalize on growth opportunities
- Keep you on track toward your goal
- Minimize loss
- Help you automate decision making (e.g. decision-tree frameworks or escalation pathways)
Step 4: Risk taking
This is the part where you actually take the business risk. But by this step you’ve already planned for most of the risk you’re going to take – it’s part of the plan.
It’s worth noting this step is continuous, as waiting too long to take risks may actually be taking a risk unto itself – the risk that the opportunity will pass you by while you wait and make plans. In either event, once you take action you don’t stop.
Along the way you may tweak and add or subtract based on changes from the previous steps, but taking action is the most important step. No journey was ever made without action.
Step 5: Business risk monitoring
Using both pre-planned tools and whatever tools become available to you on your journey, monitor your key points of failure.
- Keeping fears in check so a negative wave doesn’t cause you to quit
- Tweaking or changing as needed if you veer away from your goal
- Tweaking or changing as needed if your risk tolerance or capacity change drastically due to other circumstances
- Adjusting your Risk Policy (step 3) from lessons learned along the way
Like risk policy, risk monitoring will use different tools. The key is to remember your required risk consumption then mitigate the potential downside as much as possible. Risk may be required, but facing every negative consequence doesn’t need to be.
Humans and tech working together
Since the cycle of business risk applies to any action, it requires humans. As much as technology is advancing, it is only one part of an increasingly complex world. For Dr. Rosen, this means the increasing necessity of humans as technology gets more sophisticated.
“You can educate yourself on how to things on the internet,” he said. “But things are becoming more complex and we need people to fix complex problems. Tech is there to help us plan.”
With this in mind, the business risk cycle becomes far more manageable. Entrepreneurs can run through it without technology to begin, bringing in technology to aid action and monitoring. Above all, the one benefit of technology is it can help people make better decisions and act faster.
“Think of risk as ‘to dare,’” said Dr. Rosen. “It’s something you take, not something you avoid. But manage it along the way.”