I am proud to be a Purdue grad. The institution has served me and my family exceptionally well. From my Mom before me, to my daughters after me, Purdue has been formative, and as a Dad I can say confidently a Purdue education is a great value.
Purdue’s President Mitch Daniels is a personal hero, so I was excited to see him on CNBC one morning a few days ago; his interview prompted me to watch his commencement address. The speech was brilliant; the topic was risk.
As an investor and investment professional I have been managing risk for a long time. Over what is now a couple decades, I have learned that risk is a constantly moving combination of three basic components: probability, aka math; timing or time frame; and behavior, aka decision making.
When it comes to probability, the first consideration is “bad things happen.” People get sick, jobs are lost, markets crash. The first tool in managing this component of risk is to simply accept that sometimes things won’t go our way. Once this reality is accepted, the probability part of the equation comes into play.
How often and how likely are these inevitable bad turns occurring around us? The answer to this question must always start off as “I have no idea,” but that’s when the risk management part comes in. I’ve learned the answer to this question is nearly always out there to those who seek it through investigation, research or sometimes simply intuition. Said simply, the best tool to address the probability component of risk management is logic or reason.
Reason is not always easy, and it often requires hard work. The true hazard in not doing the work to understand the probability of real-world risk, however, is that not doing “the math” often leaves with us the most seductive and non-reasoned response to risk, which is of course fear, and over time surrendering to fear often ends up being the most detrimental peril of all.
The second component of risk management is timing. The variables on evaluating timing are often cloudy. Are markets at a high or a low? How dangerous is this new virus? Is she interested in going out? We simply don’t always have the information to answer the question of timing, which is why the primary tool of addressing this component of risk management is patience.
Over time the answers to questions of timing will emerge — they always do — so the real question is how long will it take to evaluate trends and patterns. The flip side is that patience may help provide clarity, but sometimes the price of too much patience can be an opportunity. A good risk manager is adequately patient and uses the understanding of historical trends, and the knowledge of others to speed decision making. The real risk associated with timing is often inaction, which can end up being the most expensive risk of all.
Finally, the most complex component of risk management of all is behavior. We can train, study and practice facing risk, but until we experience the market crash, walk up to the girl, or get the pass for the buzzer beater in a basketball game we won’t truly understand the nature of risk. It is at the moments when the probabilities have gone against us, the timing was bad or the unthinkable becomes real that decision making rules the day. Do we sell low, pose the question, or take the shot? Do we take advice, listen to the coach, read the data? The primary tool for managing this component of risk management is experience, and unfortunately this tool is truly only earned in one way.
Over the past 15 months our society has done simply a horrendous job evaluating and managing risk. In hindsight, the mistakes will be analyzed and new knowledge will be added to the human experience. The good news is every single individual has now faced a collective and unknown risk, formulated a response, and learned something in the process. Hopefully, this shared experience will make us all better risk managers in the future. The societal benefits of this learning curve could be the greatest gift we could have given ourselves.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
