Dealing with Life’s Risks

jumping ledge
 
BASE jumping is one of the most dangerous sports a human can undertake, with one fatality per 60 participants. The desire to jump from great heights is practiced by a small percentage of extreme sports enthusiasts. BASE jumping, like sky-diving, skiing potentially fatal slopes, or rock climbing without a rope, is a high-risk activity.
 
According to The New Zealand Medical Journal, the likelihood of injury or death from BASE jumping is 5 to 8 times greater than skydiving. Why would any sane person take such risks? Dr. Erik Monastery, one of the authors of the study, noted that BASE jumpers score high on a measure called novelty seeking: the person’s propensity to become easily bored and look for exciting activities. They also have a low sense of harm avoidance, so they have the advantage of “confidence in the face of danger and uncertainty, leading to optimistic and energetic efforts with little or no distress.”
 
Some have characterized those who regularly take such risk as adrenaline junkies or daredevils. They actively seek sensation in activities like skydiving. Dr. Cynthia Thomson of the University of British Columbia suggests that risk-taking behavior may be genetically based. Her research found that people attracted to dangerous sports shared a common genotype, a variant of the DRD4 receptor commonly called the “adventure gene.”
 
So, is risk-seeking behavior genetic or a matter of choice? How can we use these answers to make better decisions and lead happier lives?

What Is Risk?

Uncertainty pervades every aspect of life; the future is unknown. The term “risk” refers the negative aspect of that uncertainty – the possibility that something harmful may or may not occur. Risk differs from loss just as uncertainty differs from certainty. Running across a busy street blindfolded is a risk; getting hit by a car while doing so is a loss.
 
Risk is present in everything we do. For example, a person could be injured by a herd of stampeding zebras while walking the streets of Manhattan, although there are no recorded instances of such occurring.

Probability

For that reason, the Stanford Encyclopedia of Philosophy refined the definition by replacing the word “possibility” with “probability.” In common terms, risk is referred to as “odds.” For example, the probability of your home being damaged by a fire in the coming year is about one-quarter of 1% (0.0028%) while the probability that you will die in the future (based on current science) is 100%. The risk of death is not an if, but when. However, probability alone is not enough to understand risk and effectively manage it.

Impact

A second dimension of risk is consequence. In other words, what is the impact upon those experiencing the event? The impact may be slight or catastrophic. For example, the probability of the paperboy tossing your morning edition into the shrubs sometime during the year is high, but the consequences are slight (inconvenience and possibly scratched retrieving the paper). On the other hand, the likelihood of a tornado destroying your home in Elmhurst, New York is low, but the financial costs of such an event would be significant.
 
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3 Risks of Investing in the Stock Market – Volatility, Timing & Overconfidence

dice invest-918x516Risk and reward are inextricably intertwined, and therefore, risk is inherent in all financial instruments. As a consequence, wise investors seek to minimize risk as much as possible without diluting the potential rewards. Warren Buffett, a recognized stock market investor, reportedly explained his investment philosophy to a group of Wharton Business School students in 2003: “I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out.”
 
Reducing all of the variables affecting a stock investment is difficult, especially the following hidden risks.

1. Volatility

Sometimes called “market risk” or “involuntary risk,” volatility refers to fluctuations in price of a security or portfolio over a year period. All securities are subject to market risks that include events beyond an investor’s control. These events affect the overall market, not just a single company or industry.
 
They include the following:
 
Geopolitical Events. World economies are connected in a global world, so a recession in China can have dire effects on the economy of the United States. The withdrawal of Great Britain from the European Union or a repudiation of NAFTA by a new U.S. Administration could ignite a trade war among countries with devastating effects on individual economies around the globe.
Economic Events. Monetary policies, unforeseen regulations or deregulation, tax revisions, changes in interest rates, or weather affect the gross domestic product (GDP) of countries, as well as the relations between countries. Businesses and industries are also affected.
Inflation. Also called “purchasing power risk,” the future value of assets or income may be reduced due to rising costs of goods and services or deliberate government action. Effectively, each unit of currency – $1 in the U.S. – buys less as time passes.
 
Volatility does not indicate the direction of a price move (up or down), just the range of price fluctuations over the period. It is expressed as “beta” and is intended to reflect the correlation between a security’s price and the market as a whole, usually the S&P 500:
 

  • A beta of 1 (low volatility) suggests a stock’s price will move in concert with the market. For example, if the S&P 500 moves 10%, the stock will move 10%.
  • Betas less than 1 (very low volatility) means that the security price fluctuates less than the market – a beta of 0.5 suggests that a 10% move in the market will produce only a 5% move in the security price.
  • A beta greater than 1 (high volatility) means the stock is more volatile than the market as a whole. Theoretically, a security with a beta of 1.3 would be 30% more volatile than the market.

 
According to Ted Noon, senior vice president of Acadian Asset Management, implementing low-volatility strategies – for example, choosing investments with low beta – can retain full exposure to equity markets while avoiding painful downside outcomes. However, Joseph Flaherty, chief investment-risk officer of MFS Investment Management, cautions that reducing risk is “less about concentrating on low volatility and more about avoiding high volatility.”

Strategies to Manage Volatility

Strategies to reduce the impact of volatility include:
 
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