Monday, August 02, 2010

Profiling Risk

My risk profile is something I think about, it causes me great uncertainty. So when my Pricing Theory class addressed it it was probably the first time I've been glad to see human behaviour depicted by a graph.

You see, I'm trying to be a risk taker, but I don't think I'm a natural gambler. For example, I wouldn't gamble. But my obsession with failure has lead me to an unnatural risk profile.

So first let's just look at the most broad risk profiles:

This person is risk averse, the curve of the graph indicates that their 'utility' or 'consumption satisfaction' decrease faster than it increases. So for each dollar of income or whatever they gain the feel nice, but for each dollar they lose they feel terrible. They are more scared of losing out than they are of winning.

Now here's the risk enthusiastic:

This person due to the shape of the curve, gets more utility for an increase in income than they do from a decrease. They are all like 'woohoo' when they win a dollar and all like 'whatever' when they lose one.

So which one am I? Well it depends...

My attitude is this - 'I'm not important enough to worry about failure' if I went bankrupt tomorrow nobody and I mean nobody would lose out on it (except me). There would be no front page story on the Age, Herald Sun, Financial Review or Wall St journal.

Furthermore if somebody was like 'tohm you have to go live in a park now' I'd be able to deal with it (until I died of pnuemonia) but whatever... I have a high pain/discomfort threshold with a few caveats I'll come to later.

But I get these natural highs when I succeed. Like if I draw good and people like it I'm buzzing. I'm willing to sacrifice the income I could potentially be earning to give myself an opportunity to draw. Success at something I want to do (even the smell of it) is much more rewarding than 'successfully failing' as I've come to dub it.

So this is what I mean by being 'unnaturally' risk averse. I don't care about the consequences because I don't really care about me.

Now the caveats, I think our risk preferences have something to do with our broader behavioural prefences aka Jungian psychological profiles. I'm INTP or something I haven't done the test in a while, but on the simpler one I'm an 'Amicable' or an 'Amicable/Expressive' person.

So let's start with the key differentiator - Introvert/Extrovert. This is one of those counter-intuitive things where people assume an extrovert cares more about other people because they are more social. But when you dig deeper its infact the opposite. Extroverts socialise so more people can care about them, introverts are the opposite they care little about themselves relative to other people, hence they hang back, they observe they whatever.

I'm an introvert, I've trained myself to act extroverted over the years but I know that meeting people socialising etc drains my energy. I get rewards out of it but it costs me. Others get energised by meeting people and talking to people and what not.

So here's the boundaries of my risk profile. I'm happy to take risks for myself, where the brunt of the consequences effect me and me alone. I balk at the idea of taking risks on others behalfs. The thought of hurting somebody else kills me. So I am risk enthusiastic with myself because hey whatever shit happens I'll deal with it, I can crawl out of the abyss anytime. But as an Amiable person the thought of causing hurt or embarassment to somebody else in any capacity I am very averse. I'll do almost anything to avoid it.

BUT then I need a second wave of caveats.

I kind of feel contempt for people in my quasi professional capacity as financial advisor (I'm not qualified yet, but people keep asking me). Talking investments is unflattering to most people, it's not a good look and it breeds contempt in me.

Because most people are risk averse, they fear losses more than they relish gains. But they aren't idiots, most peoples biggest fear is a loss of income (except that very few take out income insurance) and that is because they are focussed on retirement. They aren't (particularly) stupid and understand that inflation may erode the purchasing power of their savings and thus a paradox is created.

Peeps want as much profit and money as possible with no chance of losing. They see not making big profits or returns as risky (because of inflation) but they see the risks associated with high return securities as risky. Thus people are naturally attracted to 'sure things'

In investment Law we are looking at the case study of Westpoint mezzanine finance group scandel where many retirees were dooped out of their savings by what in essence was a ponzi scheme. That's a world of hurt, but I do feel a kind of contempt for the victims - they invested in property development for high interest payments of 12%, they were reassured by the fact that for every $100m borrowed there was $110m in presales. Thus a risk free 12%. Nobody stopped to ask 'If they honestly have $110m presales, then why wouldn't a bank lend them money at 10%, 8%, etc. why take the additional burden of mum and dad investors money and pay them exorbitant interest when a big capable institution can assess risks for themselves?

So more paradoxes, there's this cliche of 'the greatest risk is taking no risk at all' or in a sporting analogy 'you miss a hundred percent of the shots you don't take' but people who keep their cash under the bed because they are scared of bank insolvency will have all their savings wiped out by inflation if not burglery.

My plan if I become a fund manager, hedge fund, financial planner is to drive these mum and dad investors away with extremem prejudice. I don't want to do business with people who don't want to be accountable for their own decisions. I could take risks with other peoples money if they have a similar attitude to me. I imagine I will only end up with the small change of people I can only make richer, but I'd rather play with $10k of pocket change from a millionaire than $10k of savings for your average joe.

Then again, as I actually achieve stuff through risk taking, my profile will probably change, I will feel vulnerable on account of my achievements and start to fear losses rather than gains. My plain is to live a fairly spartan lifestyle, like Buffett only draws a $100k salary even though he's worth 60+ billion or something now.

Anyway confusing, it's hard to take risks when you don't know how you feel about them.


Skylar Ernest said...

You are Jesus.

Brham13 Silva said...

Both individuals and organizations need to consider Risk Profiling at all stages. While organizations assess their risk profile to find out what threats they are vulnerable to, individual’s risk profile gives the person an approximate idea about what sort of levels of risks they are willing to take.