What Can the Pandemic Can Teach Us About Risk?
Dan Sinnen, Partner & Senior Wealth Advisor
Morgan Housel, leading finance author and one of my favorites, is recognized in our industry for his insight into investing and behavior. Having grown up a competitive skier, Morgan was asked during a conference what skiing had taught him about investing. Initially, he didn’t think very much, but as he started to respond to the question, a painful memory came to mind.
While at a ski resort with his high school team, two of Morgan’s teammates were killed on the slopes by an avalanche. At the time, he couldn’t realize the impact this tragedy would have on his life. This event changed his perspective, not only on investing, but with life as well. Morgan’s risk tolerance plunged. He hasn’t skied much since the accident. It scares him.
Since that terrible accident, he has become a risk-averse person. He drives the speed limit, obeys all seatbelt rules, and invests in index funds. So how does this relate to investing?
That childhood tragedy taught him there are three sides of risk: the odds you will get hit, the average consequences of getting hit, and the tail-end consequences of getting hit. The first two consequences are easy to understand, but the last risk is hard, and potentially learned only through experience. Morgan knew there were risks when skiing, but never did he think his teammate would pay the ultimate price. After a painful incident like this, you realize the tail-end consequences are all that matter. These are low probability, but high impact events.
We know that when we invest, there are risks. Economic data and news headlines tell us the average risks. However, it’s the tail-end consequences or risks, like pandemics, recessions, and depressions that matter. Too often we get wound up by fluctuations in the stock market, our portfolio performance, or comparing our friends and family’s investment performance to our own.
I think Morgan’s words tell us that you may never know what experience has led someone to their risk tolerance. You would think someone in his position, an expert in economics and finance, would be an aggressive investor, but a tragic event altered that mindset.
How has the pandemic altered your thinking and feelings about investing? At the end of the day, risk is our comfort level towards a series of events. The most important part of your financial plan is to ensure your investments are doing the job to fund your values, wishes, and goals. It does not matter if your neighbor did 5% better this year. What matters is you are taking appropriate risk within your comfort level knowing the potential tail-end consequences.
Is chasing after that better performance worth it? Hopefully, it’s not another high impact event that teaches us it wasn’t.