What do you mean by “Risk”?
October 25th, 2007 by Grant in: Business, Economics, Finance, Frugal Living, Investing, SavingI read a post by Robert Frank at The Wealth Report blog hosted by The Wall Street Journal Online today that left me scratching my head.
It might be my engineering background that had me thumbing my nose at the post, but generally it’s my propensity to question what they’re not telling you that really had me intrigued.
The author noted that as evidenced in the book “The Millionaire Next Door,” it’s those who pinch their pennies, drive old pickup trucks and make conservative investments that end up getting ahead in the financial game.
The author goes on to say that this philosophy is contrary to his experience in observing the wealthy. He says that it’s those who are willing to take more risk that end up with all the money, meaning multi-millions of dollars.
The author goes on to quote a Barclay’s report, stating:
Today, Barclays Wealth released a report along with the Economist Intelligence Unit that found 60% of individuals with investible assets of $1 million or more said “a high appetite for risk has been an important influence in their wealth creation.” That compares with 36% of those surveyed with assets under $1 million. -Source
From this, Frank drew the conclusion that those who wage lofty bets end up with all the dough.
I think there are two things to remember here:
1. Risk is relative. Bill Gates can invest $1 million in the startup down the street, lose it all and not feel too bad about the deal. His quality of life hasn’t changed much. I, on the other hand, would go back to eating Ramen Noodles every night like I did in college… while I worked off the $1 million loan from Bill Gates.
2. For every person that bet the farm and made millions, there are at least 5 who bet the farm and winded up eating Ramen every night.
3. As a general observation, we tend to highlight the successful entrepreneurs, and brush
off the failures. Much like the weight loss commercials: Here are 5 people that tried our program and lost 100 lbs… and boy don’t they look great. Never mind the hundreds of others who gained 30 lbs and dropped out…
So what is your definition of “Risk”?
In general, I don’t think we can talk about risk without using a sliding scale. Appetite for risk is based on a number of different variables, and it’s rare that you can take two success stories and compare them without someone making an apples to oranges analogy.
And then there’s luck…
Now. Back to finding the next buy-it and forget-it stock that’s going to make me millions!
Tags: fortune | Investing | making money | Risk
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October 25th, 2007 at 1:49 pm
I find such reports and even the books like Millionaire Next Door meaningless.
In my experience, the few people I know who have become wealthy took a huge risk at some point. But it was not taking the huge risk that made them wealthy. They are wealthy because it turned out good. I don’t know how many others may have taken the same risk and rolled snake-eyes, so I don’t know that the folks who made out really made a rational decision in the first place.
I will never get to be a billionaire if I don’t take some rediculous risks. Maybe robbing a bank then taking all the proceeds and putting it on some out of the money stock option. If I get away with the robbery, and the stock soars, does that mean I made a smart decision? No way. This type of analysis after the fact is rampant and utterly flawed.
October 26th, 2007 at 3:25 am
Here’s what I think: people that make a lot of money making seemingly ‘risky bets’ do so because they embrace risk and are not afraid of taking action when the information given to them warrants making a decision. One of the biggest traders I know might be offended if you called him a risky individual. Strap him in a plane and tell him to fly it? Yes, he’s taking a risk that he would consider to be out of his favor. Tell him to move 10% of the volume on a midwest commodities exchange? Done. Risk is relative, it is a perception, and it’s something some manage better than others.
October 26th, 2007 at 1:51 pm
I don’t disagree with Winston. Especially when it comes to traders. But when it comes to individuals who have made out by opening a business, or becoming a landlord, you are usually looking at someone who “rolled the dice” once, twice, or at most 3 times and one of those rolls paid off. Their result is not statistically significant. You don’t know if their risk was prudent or if they were just lucky.
October 26th, 2007 at 3:19 pm
According to the book, many Millionaire’s Next Door made their fortunes by owning their own businesses. While they may live frugally, I would consider starting one’s own business as taking on a lot of risk.
January 24th, 2008 at 8:46 pm
I’ve been rolling the dice for quite a while- hope it comes quick because i’m running out of ideas-one of the problems mike, is that “frugal” living part. I like luxuries, but at the same time, am able to save quite a bit. However, none of previous business ventures have panned out that well. Be it business model or lack of motivation, or maybe confidence, it usually collapses…:-(
February 22nd, 2008 at 12:22 pm
“I would consider starting one’s own business as taking on a lot of risk.” - Mike
You could think of the fact that having a job is a lot of risk - a manager that doesn’t like you when your performance review comes around, a career in a struggling industry, threat of buyout from a competitor, gradual obsolescence of your specialized skills - the list is quite long.
And what about the opportunity cost of showing up to work 40+ hours a week for a fixed amount of pay that may or may not out-pace inflation? In the long run I think that can turn out to be pretty damn risky, if your goal is to become wealthy.