Consider this simple definition’s far-reaching and positive implications:
It’s an empowering definition, because although we have little or no control over the future, we alone have total control over the full range of our expectations of potential outcomes—both good and bad.
-
The more realistic our range of expectations, the fewer surprises we’ll experience, the better risk/reward decisions we’ll make, and the better risk managers we’ll become.
-
Our expectations of possible outcomes are under our control. That is not the case when we abdicate the control to totally random occurrences or statistics.
-
It gives us the power to influence the fact that risks with the greatest negative impact are typically those risks that aren’t expected or we’re not normally prepared for.
-
It helps us think through the full range of possibilities while recognizing that surprises happen all the time.
-
We have the power to ignore, accept and prepare for what we expect.
-
It gives us the power to deal with negative and positive variations from expectations.
When we know, understand, and are prepared for risks, the very nature of that understanding and preparation can neutralize risks that do occur, and convert them from possible nightmares into minor inconveniences, and even potential opportunities.
C. Be Sure You And Your Clients Agree on the Same Empowering Definition of Risk.
Clear, open and unambiguous communications between a planner and every client is critical to maximizing the effectiveness, value and ultimate success of a planner’s advice. No single element of planner/client communications is more important than being certain that you, your clients and potential clients are in complete agreement on your shared definition of risk.
So in the early interactions you have with clients and prospective clients, remember to ask them their definition of risk. If they’re using a restrictive or limiting definition, then share with them the empowering definition you prefer to use below, as well as its many benefits reviewed previously.
Risk: “The degree to which an outcome varies from our expectations.”
Then mention how important it is to clear communications and effective risk management that you both share the same definition for a term that’s so fundamental to investing, and ask them if they like your empowering definition of risk better than the definition they first mentioned. If so, then confirm with them that your definition will be the definition you’ll both be using for the term risk in all your communications and interactions with one another.
D. What Generates or Causes Risk To Occur?
At its most fundamental level, risk—or the inherent potential for things to break down, fail, not work or deteriorate is the result of one of the most fundamental of all the natural laws of the universe. As specified by the second law of thermodynamics, entropy is the basic natural characteristic of everything in the universe to move from order to disorder and randomness or from a higher level of energy to a lower level of energy, unless external energy is expended to maintain that order.
The increasing randomization of energy, entropy, is part of the basic structure of the universe. Entropy is why broken windows don’t fix themselves, why heat flows from a hot object to a cold object and not the other way around, why sugar and salt crystals dissolve in water and don’t un-dissolve. It’s also why paint eventually peels and degrades, and iron rusts.
Bridges and building will eventually collapse unless entropy is countered by the addition of new energy, money, power or labor into the system. Its also why, as we know so well, that money has a strong tendency to dissipate, and randomize. Entropy is why businesses fail, and investments don’t maintain exceptional performance indefinitely. They have a tendency to sour unless we enhance success by inserting additional energy in the form of new strategies, research work, new people, new management or injecting further capital into the business, etc. The second law of thermodynamics decrees “that anything that can go wrong not only will go wrong, it must go wrong.” (We just don’t know when.)