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Whatever we do, we deal with risks. Despite our best laid plans and intentions, there are always those uncertain and unwanted events that happen which are beyond our control. In previous posts, I have talked about risks on projects. This post deals more with risk behavior. Risk management (or, risk tolerance) covers the spectrum from total avoidance at all costs to a laissez-faire, what-does-it-matter attitude. A low risk tolerance leads to “safe” choices that eliminate, or substantially reduce, an unlikely event with a negative impact occurring. Likewise, a high risk tolerance leads to choices where outcomes are unpredictable and not guaranteed. In this scenario, the chances for unlikely risks occurring are higher. Financial investors know their level of risk tolerance and how it influences their investment choices. The occurrence of a highly improbable event that may not always be planned for. The impact can be positive or negative.
There is a related effect with investors called the “Black Swan” that describes what happens when an uncertain, unstable event does occur. In a 2007 book by Nasim Nicholas Taleb, titled “The Black Swan – The Impact of the Highly Improbable“, it is defined as:
- an event that is unpredictable (an outlier)
- has a massive or, extreme impact and
- after it happens, we create rationale to make it more predictable (less random)
Taleb makes a living betting on the occurrence of “Black Swans”. He is a contrarian when compared to the typical financial investor who avoids risk by seeking the small gains in the stock market. The positive effect of a “Black Swan” is seen over time. Likewise, a negative “Black Swan” happens very quickly. For most investors, the preference is to avoid the downside risk of a negative “Black Swan”. Managing risk can be tricky business. Taleb has 2 observations related to risk assessment I would like to highlight:
- We have more confidence in what we know is wrong than in what we know is right
- We over-estimate what we know and conversely, underestimate our uncertainty
The first point bears repeating. We are more certain about something we know is wrong. Our intuition, skills and experience tells us what is wrong. Sometimes, we know something is wrong when we see it. That confidence drives our behavior with money, work and our personal life more than we may want to admit. I think that is because we are better at dealing with failure than success. We plan for success, of course, but realize we have to deal with a minimal level of failure.
The other observation related to uncertainty I have seen at work many times as well. Providing accurate estimates is a skill built on experience and dealing with knowns. When faced with new challenges, it is tempting to minimize complexity. How hard can this possibly be? More than likely, it is harder than you are able to imagine at this point in time.
When a risk is deemed highly improbably, we tend to not spend much time and energy thinking about it. When a negative “Black Swan” strikes, the risk mitigation(s) you have defined will be quickly tested. If your tolerance is low, you will have well thought out and documented options. Your sponsors, stakeholders and clients will benefit from and appreciate your efforts. The path forward that is selected is based on their risk tolerance of those negative “Black Swans”. Positive “Black Swans” can only make things better, right?
What’s your risk tolerance? What method(s) do you use to deal with uncertainty?