Bad Risk, Good Risk: Minimize Downsides and Maximize Upsides
"Risk" is typically seen as something to be avoided. "Play it safe, work hard, and avoid risks," they say. Jobs, opportunities, investments, adventures, actions—many things can be "too risky." Too much risk is bad.
But there are also good risks. When is a risk good? We'll get to that. First, let’s define bad risk, which should be more familiar.
Risk is the possibility of loss or injury. An exposure to danger or peril. A chance that something bad will happen. Common risks include standing on top of a step ladder, joining a Zoom call wearing only a shirt, and bench pressing heavy weights by yourself.
We take risks because, in addition to the chance that something bad will happen, there’s a chance that something good will happen, too, and we’re pursuing that good. We might stand on top of a ladder in order to reach something (without making a special trip to the hardware store to buy a bigger ladder). How do we weigh that risk? The bad outcome of falling and breaking bones is a disaster, but the chance of actually falling feels small, so it can seem like a risk worth taking.
Some numbers can illustrate the point. Let's say that reaching something quickly is worth an arbitrary 10 points and there’s a 95% chance that we’ll do so without getting hurt. Falling off the ladder is worth -10,000 points, but only has a 5% chance of happening. The “expected payoff” of taking a chance is the magnitude multiplied by the likelihood. So 10x95% = 9.5, compared to the bad case of -10,000 * 5% = -500. That’s a positive of 9.5 points at the expense of -500 points. If these numbers are anywhere near the right ballpark, then this is clearly a bad risk to take. We have an intuitive sense of this—you might stand on top of a step ladder every once and a while, but you hopefully wouldn’t do it everyday. Intuitively, you know it’s a net negative.
Because we tend to think that bad things won’t happen to us, we may take bad risks like this every once and a while. It’s not a good idea. Some things can result in life-altering or life-ending disasters. If it’s really a bad risk, then it shouldn’t be done, period.
Now let's define good risks. Good risks are risks we should take as often as possible. These are cases where the good outcome is really good and the bad outcome is not that severe. These risks are asymmetrical, a concept that comes up frequently in Nassim Nicholas Taleb's book Antifragile. For example, asking a girl on a date has a small potential downside (she rejects you), and the large potential upside (she says yes, you date for a while, get married, live happily ever after).
Asking for a raise or a promotion when you think it’s appropriate is a good risk. You’re not going to get fired for asking, so the worst case is usually that it could make things awkward for a while. The upside is more money or a higher position. Those are benefits that can open more doors later on, in addition to what you get right away.
Starting a business can be a good risk, depending on the situation. Borrowing $100k to do something you’ve never done before? Bad risk. Leaving your job to go independent with no guarantee of success or backup plan? Bad risk. Starting a side hustle on the weekends and trying to grow it to the point where you can quit your day job? Excellent risk. The potential downside is that you waste time, which you would have wasted watching Netflix anyway, while learning something about starting a business in the process. The potential upside is being able to work for yourself and grow your income on your own schedule.
Here's another good risk: Going to a networking event to meet new people. The worst case is that you’ll have wasted time, or maybe make a fool of yourself if you drink too much. The potential upside is that you might meet someone important: a future spouse, a key business contact, or a lifelong friend.
No matter what the situation, the key is being able to correctly judge which risks are good (large potential upside, little potential downside) and which are bad (large potential downside, little potential upside). Then, think about good risks as the opportunities they are.
Covering your bases
The chance of true disaster (injury, bankruptcy, destroyed relationships, etc) is the key factor that makes many risks bad. What if you can reduce that chance of disaster? That would move the risk toward the good risk category. The more good risks you can take, the more likely you are to be successful.
Here are some ideas to cover your bases and lower your chance of disaster:
- Get rid of your debt and as many regular payments as you can. If you can afford to live on very little, then you can better afford to take risks changing jobs or starting a business.
- Get in shape. Eat well, lift weights, exercise, and move your body. Even a little bit of physical conditioning will drastically reduce your risk of physical injury.
- Build social capital. Get to know people in your community, invest time in friendships, and be generous. Not only does it open up more opportunities, but having caring people around you is the best way to protect against disaster. If my life fell apart, I know that my friends would help me get back on my feet.
Once your bases are covered, find these good risks with asymmetrical rewards—small downsides but large upsides—and keep taking swings. Plan ahead and you’ll make your own luck.