Risk Tolerance: How do you personally define risk?

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2518623 < In life, there is no such thing as a guarantee. Everything we do always has an element of risk, however, we do not consider every day things like driving to work or crossing the street to be “risky”. Today I googled “the definition of risk” and this definition came up from thefreedictionary.com: risk (rsk) n. 1. The possibility of suffering harm or loss; danger. 2. A factor, thing, element, or course involving uncertain danger; a hazard: “the usual risks of the desert: rattlesnakes, the heat, and lack of water” (Frank Clancy). 3. a. The danger or probability of loss to an insurer. b. The amount that an insurance company stands to lose. 4. a. The variability of returns from an investment. b. The chance of nonpayment of a debt. All of the definitions above involve some form of loss, hazard, suffering and an element of variability, probability or chance. What I find to be interesting about risk is that every single person I meet has a different subjective definition. Often, when I am discussing risk with another investor, I will ask what their personal definition of risk is. More often then not, investors will define risk as the chance or probability that he or she loses on an investment. This definition is sufficient, but I find it to be a very unsophisticated definition of risk. Robert Kiyosaki says that intelligence is the ability to make distinctions. The more distinctions we can make, the more intelligent we are. For example, there are over 7500 variations of apples in the world. When it comes to apples, I am not unsophisticated and can only name a few variations: red delicious, granny smith, crab apples, and Macintosh. When it comes to apples, I am very unintelligent. A person who can name 100 variations of apples is much more intelligent than I am on the subject of apples. When I hear a person’s definition of risk, I can immediately find out what their sophistication level is when it comes to business and investing. My personal definition of risk has changed many times throughout my life. I used to believe in luck, and now I do not. All I believe in is actions performed and numbers. Life and business are a numbers game, if you can produce the volume and hit the numbers, you will succeed every time. There is no luck. My definition of risk is: Risk: Take an inventory of the elements that are under your control and compare them to the elements that are out of your control. Then ask yourself: am I ok with this? If you are ok, then proceed with the risk. If you are not ok with the degree of control, then do not proceed. My definition of risk has two primary distinctions that the average person’s definition does not: 1) My definition of risk assesses your degree of control in a situation 2) My definition asses your emotions and how you feel about your level of control Notice that I eliminate “probability” or “chance” from my definition of risk. In my world, there is no such thing as probability because failure is not an option. Naturally, there are things that can happen outside of my control, and I must address and mitigate all contingencies before proceeding. Should something outside of my control become an issue, the question is: how do we recover form this position? In my world, I understand that in life and in business, plans fail, people fail, systems fail, markets fail and what is more important than relying on all these imperfect elements is to understand how to recover and “fix” the failures. I build failure and multiple contingency plans into my ventures and understand that failure and recovery is part of the game. In real estate, between 5% and 10% on the balance sheet will be factored in for vacancy on multi family buildings. Restaurants and traditional businesses will build theft into their balance sheets. Sophisticated business people understand that failure; loss and recovery are all part of doing business and factor it in to their projections and balance sheets in advance. My definition understands that there are elements in our control and out of our control. There is no luck; only degrees of control. If you are ok with your degree of control, then proceed with the “risk”. Of course, there is always that moment where we must “take a leap of faith” and no amount of due diligence can protect us from the elements that are out of our control. What is most important when entering an endeavor with risk is to ask ourselves “how do we escape if we want to exit?” For myself, I love real estate because no matter how bad things go, there is always a large tangible asset attached to the venture that can be liquidated to recover my investor’s capital. Again, we come back to elements under control and elements out of control. When raising capital from an investor or considering a “risky” venture take them through the following scenarios to asses if the venture is right for them: 1) The best case scenario – everyone loves this scenario, and it rarely happens. 2) The realistic scenario – this is the likely outcome 3) The worst case scenario – this is second most likely scenario 4) The nightmare scenario – this is as bad as it gets, you don’t want to find yourself in the nightmare scenario. For myself, I have a low risk tolerance and I always say to my capital partners “if you are ok with the nightmare scenario, then we are ok to do business” At the end of the day, risk is all about emotions. If we are emotionally ok with our degree of control in the risk and how the nightmare scenario would affect our life, then we are ready for the risk. If we cannot handle the elements out of control and would not be able to live with the nightmare scenario, then the risk is not for you. There is a famous saying “nothing ventured, nothing gained” and we must all take calculated risks in our pursuit of success. The question is, after exploring a few definitions of risk, how do you personally define risk going forward? Your personal definition of risk is extremely important because it will define which

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risks to take and which ones to avoid. To paraphrase Sun Tzu, know yourself and know your enemy and you will be victorious in every battle. Thanks for reading, Stefan Aarnio theexclusiveinvestor.com < P.S: Please share this article if you found it helpful