Make no bones about it, risk is scary.
While culturally we put entrepreneurs, daredevils, superheroes, and any other high-risk archetypes on a pedestal, the reality is risk inherently opposes our human nature.
We are biologically and evolutionarily programmed to be risk averse. It’s primal. Professor of psychology Paul Slovic says it best, “Risk is an invention of the human mind to help people deal with things that can be harmful and dangerous.”
For the vast majority of our existence as a species, we’ve built and refined a brain center that responds lightning fast – literally within milliseconds – to any perceived threat.
Unfortunately, our brains are not yet great at separating life or death risk from little-brother-hiding-behind-a-corner-to-jump-out-and-scare-us risk.
A recent study by FINRA found that “60% of respondents indicated feeling anxious when thinking about their personal finances, while 50% of respondents indicated feeling stressed when discussing their finances.”
Both anxiety and stress are fear-derived emotions rooted in the same fight or flight response triggered by perception of risk.
So in other words, the MAJORITY of people are completely overwhelmed by negative biological responses when approaching their finances.
Our logical brain works five times slower than our emotional and survival brain, which means in order to actively engage with anything we perceive as risky, we have to work HARD.
Today we’re going to slowly walk up to risk as it pertains to investment, observe it slowly, maybe start to peel back its layers, and hopefully walk away with an understanding that investment risk might not be the real monster under the bed.
To state the obvious, money is risky!
People like to draw a hard line between investment and non-investment risk, but the reality is not so black and white.
The median year-over-year inflation rate of the 20 largest national economies is 7.75%. Dollars, pounds, euros, pesos, yen – all fiat currencies are a risk.
561 U.S. banks have gone bankrupt since 2001. Banks are a risk.
Each year there are an estimated 20,800 mattress fires in the U.S. Cash under your mattress is a risk.
Don’t get us wrong, trusting national currencies, banks, and the security of your own home are pretty safe bets. The point is, investment risk is not an on/off switch. No matter what you do with your money, you’re risking it to some degree. We’re all on the risk spectrum – nobody gets to sit on the sidelines.
With money, it’s important to also consider the other side of the risk coin. In other words, not just the decisions you are making with your money, but the decisions you’re not making.
Commonly, it’s referred to as opportunity cost: the loss of potential gain from other alternatives when one alternative is chosen.
It’s important to note that opportunity cost can also trigger a fear-based response. When evaluating what financial gains you might be missing out on, it’s important to evaluate your level of FOMO. We are not at all advocating that you take on investment risk primarily because you are afraid you’re not making generating as high of a return as you could be.
Nevertheless, opportunity cost is important, and ultimately it’s up to you to decide what level of risk is best for you. Now that hopefully we all understand that there is no complete avoidance of financial risk, understanding the importance of choosing one place for your money over other alternatives becomes essential.
The most common approach to evaluating how you want to engage in investment risk is defining your “risk tolerance.” Based on a number of factors, like your income, age, and financial goals, many financial advisors and investment services can help you determine what investments may be right for you, given your risk tolerance.
The problem with this framework is that risk is not a one-time decision. If you’ve gotten to this point, it’s important to understand that risk tolerance is a living, breathing evaluation tool, not a one-and-done decision.
It may provide comfort to some to have such a formulaic approach to risk, but it isn’t human. As we’ve discussed in previous blogs, part of the mission of Daizy is to help investors find new ways to get excited about their financial health, future, and investments. In order to do this, we have to allow for curiosity, exploration, and learning.
Oftentimes, investors get stuck in a risk tolerance box, but in order to develop a healthy relationship with investment risk, we believe it’s important to get comfortable with change, try new things, and implement new ideas.
With this framework, we can all learn to engage with risk in a more healthy human way. Maybe you want to try investing small amounts into higher-risk assets that don’t necessarily fit your risk profile. Maybe your values align with a certain company that might not look great on paper. Maybe there’s a certain industry that you’re deeply passionate about that you want to participate in financially.
Over the long term, engaged investors are better investors. So by learning to actively interface with risk, we’ll not only build a healthy relationship with it, but we’ll also learn, build, and get excited about our identities as investors along the way.
Investment risk isn’t the enemy, but our response to it can be. Forgetting about the risks you’re taking when things are going well, or regretting the risks you’re taking when things aren’t going well – the sudden oscillation between the two is an all too common dynamic that is toxic for financial well-being.
Daizy opens the door to data and resources that help you build a healthy relationship with investment risk. Our goal is to empower you to stand up to fear, anxiety, and stress, and become a better risk-taker.
And maybe the risk won’t be so scary after all.