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What is risk?

What is risk?
Image source: Getty Images.

Risk taker or risk averse? Most of us instinctively think we fall into one of the two categories, but risk is a funny old thing and chances are you take a lot more of it than you realise.

So, what is risk?

In a general context, risk is defined as ‘a situation involving exposure to danger’ like skiing down a black run in a white out (which is scary, but a whole lot of fun). When it comes to finance, risk is the potential of losing money or not getting the return you hoped for.

In the case of both of these definitions, risk is a scenario we actively choose to participate in. The consequences are also pretty clear cut. In other words, do X and the risk is Y. In the examples above, you either ski to the bottom with all bones intact – or not – or you walk away with a heap of money – or not.

Are the consequences always bad?

Some risks are there for the taking, with no one but the risk taker facing the consequences. For instance, take global logistics expert FedEx. According to Statista figures, FedEx revenue hit nearly $70 billion last year, yet the firm owes its existence to risk. With just $5,000 left in the bank (not enough to cover fuel costs), FedEx founder Frederick Smith gambled every last dollar in Las Vegas.

The gamble paid off (literally) to the tune of $27,000, which he reinvested into his ailing enterprise. The rest, as they say, is history and proof that not all risk has terrible consequences. Even had he speculated and lost; the loss would have been primarily his.  

Can we measure risk?

Ask an underwriter and they’ll probably say yes (it’s their job after all). And ultimately, that’s what insurance is all about – measuring risk. In order to do that, underwriters assess the probability of something going wrong. This is done by evaluating reams and reams of data. It’s why younger drivers pay considerably more than the average for car cover – because statistically, under 25s are more likely to be involved in a road accident.

But risk is everywhere and most of us don’t stop to analyse data before we do something. In theory, every time you drive, you run the risk of an accident. Every time you leave your house unattended, you risk a break-in. Every time your dog eats a sock, you risk going to the vet for treatment. The list could go on.

Crucially, in these examples, the risky elements aren’t necessarily scenarios we actively choose to participate in – few of us actively get into a car with the intention of crashing. Similarly, few of us leave our homes unattended in the hope they’ll be broken into. Instead, they are possible outcomes we face by simply driving or leaving the house.

Foolish final thoughts

When it comes to investing, those who are risk averse can reduce their exposure by seeking high-quality companies, likely with low debt levels, in stable industries – what we at The Motley Fool like to call Foolish (with a capital F!) investing. Whereas risk-takers might seek highly speculative potential opportunities – the “boom or bust” style that could see their investment soar in price or, indeed, plummet.

So, what is risk? It’s more than just exposure to danger or not getting the return you expect. Risk is an inherent part of the choices we make, specifically where we don’t have full control of the outcome.

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