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Risk Management

Behavioural Psychology and Risk Management

The Nature of Risk​

  • Risk is the probability of loss, not just volatility. Volatility can be a symptom of risk but is not risk itself.
  • Risk is unquantifiable, both in advance and even after the fact. The possibility of loss is a matter of opinion.
  • More things can happen than will happen. The future is a range of possibilities, not a fixed outcome.

Evaluate Risk Properly​

  • Risk is counter-intuitive and perverse. Lower prices make assets less risky, while rising prices make them riskier, contrary to common perception.
  • Risk is hidden and deceptive. An investment can appear safe for a long time before its flaws are revealed during a negative event.
  • Risk is not a function of asset quality alone. High quality assets can become risky if overpriced, while low quality assets can be safe if cheap enough.

Manage Risk Intelligently​

  • Use subjective expert judgment to assess the probability of loss, rather than precise but less relevant quantitative measures.
  • Be prepared for when things turn out differently than expected. That is the essence of risk management.
  • Manage risk continuously, not sporadically. Risk control is always needed since we never know when bad things will happen.
  • Take risks you understand, can analyze, diversify, and are well-compensated for, like an insurance company.
  • Assemble portfolios that produce good returns if things go as expected but also control risk in case they don't. This asymmetry is key to superior investing.