Are risk and luck the same thing, just with different outcomes?
Let’s define these terms:
- Risk: A situation involving exposure to danger.
- Luck: Success or failure brought on by chance rather than one’s actions.
After reading Morgan Housel’s book, The Psychology of Money, we reframe these definitions:
The difference is that risk and luck are associated with negative and positive outcomes, respectively.
Taking another step back, you may recall events outside your control that significantly influenced past outcomes. Was that due to risk or luck?
Ask yourself these questions:
- How do you define risk, and how do you assess your risk appetite?
- Should you take more or less depending upon your goals?
- What life experiences shaped how you think about risk?
It’s nearly impossible to find any piece of news that doesn’t mention risk, but you don’t see very much suggesting luck! That’s likely because luck is harder to quantify and predict.
On the risk front, we consistently analyze risk-adjusted returns, standard deviation, Sharpe ratios, and other measures of volatility. While these items are essential when crafting an investment portfolio, we question whether it’s the most productive way to think about risk.
Our analysis of risk depends on:
- Where do you want to go vs. where are you now? How much risk do you need to take in your portfolio to get there? Does that align with your risk tolerance?
- How do you quantify the risk taken in all aspects of your life (not just in your investment portfolio)? Asked another way, do you consistently speed through yellow lights but sell when there’s a dip in the market?
In this context, there’s no single definition of risk. Whether it’s paying down your mortgage early, keeping cash under your mattress, or liquidating your savings to start a business, risk doesn’t need to be consistent, but you should quantify it in the aggregate.
As financial advisors, we’re here to craft a plan that considers your appetite for risk to help you achieve your next adventure (and the next one after that!). Let us know if we can help!