What is risk? Here’s the formal definition.
Risk: noun “Risk is the possibility that something bad or unpleasant (such as an injury or a loss) will happen”
That’s risk. Simple but often times misunderstood. Risk is not that something is “guaranteed to happen”, insteadit’s something that has the “probability of happening”.
If risk is the probability of something bad happening, then what is risk aversion?
Ask the question and the response you usually get is “I hate losing money”. Sure. Everyone hates losing money. There are risks associated with everything we do (driving, flying, careers, etc.) but does it mean we stop doing them?
The same can be said when investing capital.
Risks should be managed not avoided. Managed correctly, it grows your capital. Ignoring it wrecks your books.
Avoid risks at your own peril. Playing it safe won’t move you forward because risks and opportunities are always intertwined. Managing risks the right way opens doors for better opportunities later. You need both to generate wealth.
But why does everyone chase wealth? It’s because wealth has utility, that’s the main reason. Think about it for second. What’s the point of having a trillion dollars if there are no goods or services to buy? So that’s two more concepts to keep in mind.
Risks. Wealth. Utility. Three concepts we need to learn before we move forward. Risks we already covered.
Let’s move on to wealth and utility.
Wealth is straightforward. We measure it in Dollars, Euros, Pesos, Yen, etc. But why do we accumulate it? Because it has utility, that’s the third concept. We chase it because it gets us the nice house, the fancier car, etc.
The most important reason, however, has nothing to do with material things. The most important reason to accumulate wealth is it buys you FREEDOM!! It gets you financial independence, the ability to make choices, and most importantly, it buys you time. That’s it’s main utility and it has a little math behind it.
Three concepts to wrap your head around. Knowing all three gets you ahead of most people. We will dive into each one in upcoming posts.
