Basic Risk Reward Analysis

Every action you undertake carries a risk. No matter how small, how insignificant, how predictable or how accustomed you are with that action. There’s always something to gain and something to lose.

Because we are attached to a smooth way of living, we tend to ignore, or downplay, our risk reward analysis. We don’t stop every second and ponder every tiny step that we’re going to take.

Although, if you try to remember, this is how we started in this world. As toddlers, we were always aware of our next step (but not very good at assessing risks, though, since we were falling oh, so often). We were also very aware about the food we’re ingesting, taking the time to evaluate its taste and reject it automatically if we didn’t like. We were very vocal with our physical (dis)comfort, for instance when our diapers were wet – I’m sure everybody was quickly taking notice of that.

As we grew up, though, we saved and classified all this data in various clusters that are interacting with each other. We have rough ideas about the predictability of the vast majority of our actions. As a result, we’re able to function consistently in this world – given no major disruptions, like wars or natural disasters, are affecting us.

And yet, we’re not always getting what we want. I would say, on the contrary, getting what we want is something that we very seldom experience, and I’m sure you can relate.

There is a way of working around this.

But first, we need to reframe it. Instead of “I want to get that”, we may start saying: “I want to maximize the benefit, and minimize the risk”.

And here’s a very, very basic risk reward analysis.

Step One: Assess

This is the most important part. Because it boils down to understanding what we really want. Most of the time, this is heavily influenced by our upbringing, culture, peer-pressure, immediate and acute needs, unexpected imbalances and so on and so forth.

Knowing what you want is how you define the outcome. If you don’t define it correctly, you will never get what you want, although you may get what you want (I know it sounds like a Zen Buddhism Koan, and, believe me, this is on purpose).

Step Two: Allocate Resources

Resource allocation is the step where you take action. It’s what you do, in order to get what you want. It’s how you interact.

Resource allocation should be, at its very basic level: appropriate in size to the goal, timely and atomic. In simpler words, you gotta act with no less but no more energy than the goal requires, you should act when the opportunity arises (no sooner, no later), and, once you acted upon, leave it behind, don’t dabble in it anymore, what’s done is done.

Needless to say, it’s incredibly difficult to choose the appropriate resource allocation for each and every outcome we’re envisioning. Each situation requires a different way of acting. But that’s how, at a very basic level, our approach to resource allocation should be.

Step Three: Back To Step Number One

Once we acted, we should just get back to assessing. And we should do that as soon as possible, given the current context. Sometimes we can’t assess some of our action immediately. There are long-term and short-term goals. But if we did the correct assessment, and we know exactly what we want, assessment is possible after each resource allocation.

An Example

Let’s say you got some money aside, and you define the outcome as being financially independent (or, how I like to tell nowadays, financially resilient). As you deepen your assessment, you decide the best route with that money is to invest it (as in not building a business with it, for instance, or just give it away as charity). Now, the assessment narrowed a little. The main goal is financial resilience, but the closer outcome is a successful investment, which, if successful, will make further investment easier, or more predictable, all contributing, in the end, to financial resilience.

You go down this path until you find the object of your investment, and you made the final assessment, which is how much you want to put from that money (hopefully, not all of it), what’s the expected profit, and on what time window. This the part where our reframing, the “maximize benefit, while minimizing risk”, is the most obvious.

The next step is to just do it. Allocate resources, start moving the money, do the investment.

After that, just sit back, relax (if you can), but in any case, disconnect from this project (this is the “atomic” part of resource allocation). Come back at the end of the period in which you were expecting some outcome, and go to step number one. Re-assess. See if you established the correct goal, if the resource allocation was correct, and how far are you now on the main goal, which is financial resilience.

You may not get this right from the first time. You may not get this right from the second time either. You may not get it right even after doing it one hundred times.

But the more you do that, the better you’d get at it.

Image by pen_ash from Pixabay

Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.