Hedging your bets: How risk has many faces

 
Richard Farleigh
SMOKING is a stupidity test. I do apologise, but there’s no other conclusion. Smoking reduces life expectancy by about 10 years and smokers have around a 50-50 chance of living past 70. Their early deaths are often slow and painful. Yet about one-in-five adults choose to light up. They must be fools to be crazy enough to risk their long-term health for mere short-term rushes of taste or mood.

So for smokers, bad risk-taking is often fatal. But risk is everywhere, and everywhere we struggle with it. Sometimes we try to contain it. When we insure our house, we know we are paying above the odds. It doesn’t bother us later if our house doesn’t burn down – we don’t think “bummer, that was silly. Shouldn’t have paid that premium. Looks like the house is still there.” We are happy to pay to eliminate the risk of a financial catastrophe.

On the other hand, sometimes it can be sensible to actually create risk. When I back a startup, I am aware that it will probably fail. Indeed, most of the 80 or so that I have backed have not worked out. It’s an uncomfortable experience, and I take on the risk because I obviously believe that the peacocks will more than pay for the turkeys. This belief, that the odds are in my favour, distinguishes this and other investing from gambling – where a punter takes on odds that are known to be bad.

Even gambling, though, or buying the occasional lottery ticket, can be a good idea for some people. “What?” you say. “They’re bound to lose out in the long run!” But if we assign some value to the excitement and entertainment of gambling, then it may be okay to lose a little bit along the way. People pay to listen to music or to watch movies, so why shouldn’t people pay for a little thrill. Risk can be fun.

But it isn’t fun when risk is underestimated. We all do it and most often when we become overconfident in our views. Sometimes we think we know everything – from the trivial, “Manchester United will certainly win!” to the more serious, “the Labour Party could definitely do a better job!” Damage is done, however, when we block out other possibilities. Many business people are admired for their never-giving-up attitude, but I believe that far more people suffer when they choose to persist with a bad idea, no matter what the costs or signals to the contrary. They won’t entertain for a moment the risk of failure, and they drive themselves off a financial and emotional cliff. Watch out, your new paperclip may not be the next big thing after all.

Climate change is another example. It seems people are polarised into believing it is happening or it isn’t happening. Surely, given the current debate between experts, any layperson with a somewhat strong amateur view has to accept that there is at least a 10 or 20 per cent chance of being wrong. And what are the costs and consequences if they are wrong? Global warming could be catastrophic, and even a 10 per cent risk may be too much. I wonder if even people who dismiss climate change should be still willing to endorse drastic action to prevent it. Clearly not everyone thinks this way about risk but, then again, some people are smokers.

Richard Farleigh has operated as a business angel for many years, backing more early-stage companies than anyone else in the UK.
www.farleigh.com