Risk First
Enhancing Decision Making with an Emphasis on Risk Analysis
INTRO
Decision making is about risk and reward. We weigh the risks, compare the risks against the reward, and make our move. At least that is the way the game SHOULD BE played. We (C&P) are going to jump to a simplistic conclusion that most decisions are made based on the size of the prize, and not enough attention, time, and thought is given to the risk side of the equation. We favor going where they ain’t, and for this reason we will focus on RISK FIRST. A lot of our work at C&P is focused on risk management, so let’s take a closer look at some fun risk concepts.
A FOCUS ON RISK
We can all agree that decision making is an important skill in life. Why they do not teach this is school is a topic for another day, but this is our attempt to be part of the solution. In order to make winning decisions, it is important to have as much relevant (good) data as possible. It is up to us to gather the necessary data, whether we do our own research, ask our inner-circle, ChatGPT, or lean on trusted professionals. The “bigger” the decision, the more time and energy needed to flush-out the potential risks of the decision being made.
We often hear about an investment being high risk or low risk. Let’s be curious and ask the logical next questions: what are the higher risks, and what does that mean for this position, and how will it affect my other positions, my overall portfolio, and my life in general? This is the line of thinking and questioning we encourage. It is through the lens of curiosity that life moves forward, towards the truth and winning solutions.
We instantly see that the world of risk (and volatility) opens up an entirely new set of questions and consequences, and these questions and consequences are different for most individuals. This is why we will spend our time at C&P on the risk side of the equation, or as we like to say, RISK FIRST.
RISKS & CONCLUSIONS
Time to make a decision! Let’s lay out all the different advantages and disadvantages. Let’s talk about the pros and cons. The likes and dislikes. This is a popular way to frame our decisions.
Once we get through all of our likes/dislikes and pros and cons, it’s time to layer in the RISKS and CONCLUSIONS. Let’s write down, highlight, or talk about the major risks involved in this decision. Let’s keep asking questions until we are comfortable with the risk analysis. We now have a new set of variables (risks) to weigh against our initial pluses and minuses.
We are now set to draw our conclusions. Here are a couple of simplified examples:
MARKET RELATED
THE SCENARIO: financial stocks are beaten up, and I am thinking about adding some exposure and buying this dip in the banks.
PROS: we like trading, we like buying things that are “cheap”, and we think the group is oversold.
CONS: we already have a lot of equity exposure and the bank stocks are very volatile right now, so the risk is elevated.
RISKS: the big tail risk is that I work for a big bank. The disaster scenario I need to avoid is the banks continue going lower and I lose money…and my job.
CONCLUSIONS: we decided the tail risk is too great and to stay away from this trade.
POTENTIAL RISK MANAGEMENT: we can take a smaller position or we can work with a tighter stop (exit position if the trade moves against us by a certain percentage).
“REAL WORLD” EXAMPLE
THE SCENARIO: the kids and I are thinking about surprising mom with a new puppy for Mother’s Day.
PROS: most everyone loves puppies! A dog is a great addition to family.
CONS: puppies/dogs can be a lot of work. All the time (and money) to train, feed, and exercise is a big commitment for many years.
RISKS: the major risk is that this time requirement falls back onto me (the dad).
CONCLUSIONS: I am weighing my time vs. everyone’s enjoyment. That sounds lopsided, and I am not ready to commit my time like that.
POTENTIAL RISK MANAGEMENT: 1. Get the kids to commit (good luck with that). 2. Avoid the surprise factor and discuss as a family.
Maybe there is more than one conclusion. Maybe we will feel more comfortable with a given decision once we mitigate the one larger outstanding risk we uncovered in our analysis. Either way, we now have a much clearer picture of the full cost-benefit analysis to make the most informed decision.
OUR OWN CONCLUSION
The topics of risk and volatility are very opaque and complex. At C&P we try to break down these tricky concepts for the curious investor. A better understanding of risk and volatility do not only apply to the markets and our portfolios, but the same analysis can be performed for decision making in everyday life. With a risk-first mentality, we will be in a better position to make the most informed decision possible, and that sounds like a winning solution.