The Psychology of Money
Luck and Risk
Summary
Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort.
NYU professor Scott Galloway has a related idea that is so important to remember when judging success—both your own and others’: “Nothing is as good or as bad as it seems.”
Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. They are so similar that you can’t believe in one without equally respecting the other. They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes. They are driven by the same thing: You are one person in a game with seven billion other people and infinite moving parts. The accidental impact of actions outside of your control can be more consequential than the ones you consciously take. But both are so hard to measure, and hard to accept, that they too often go overlooked. For every Bill Gates there is a Kent Evans who was just as skilled and driven but ended up on the other side of life roulette. If you give luck and risk their proper respect, you realize that when judging people’s financial success—both your own and others’—it’s never as good or as bad as it seems.
No one actually thinks luck doesn’t play a role in financial success. But since it’s hard to quantify luck and rude to suggest people’s success is owed to it, the default stance is often to implicitly ignore luck as a factor of success. There are a billion investors in the world. By sheer chance, would you expect 10 of them to become billionaires predominantly off luck?” You would reply, “Of course.” But then if I ask you to name those investors—to their face—you will likely back down.
When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept.
Economist Bhashkar Mazumder has shown that incomes among brothers are more correlated than height or weight. If you are rich and tall, your brother is more likely to also be rich than he is tall. I think most of us intuitively know this is true—the quality of your education and the doors that open for you are heavily linked to your parents’ socioeconomic status. But find me two rich brothers and I’ll show you two men who do not think this study’s findings apply to them.
Failure—which can be anything from bankruptcy to not meeting a personal goal—is equally abused. Did failed businesses not try hard enough? Were bad investments not thought through well enough? Are wayward careers due to laziness? Sometimes, yes. Of course. But how much? It’s so hard to know. Everything worth pursuing has less than 100% odds of succeeding, and risk is just what happens when you end up on the unfortunate side of that equation. Just as with luck, the story gets too hard, too messy, too complex if we try to pick apart how much of an outcome was a conscious decision versus a risk.
Let's I buy a stock, and five years later it’s gone nowhere. It’s possible that I made a bad decision by buying it in the first place. It’s also possible that I made a good decision that had an 80% chance of making money, and I just happened to end up on the side of the unfortunate 20%. How do I know which is which? Did I make a mistake, or did I just experience the reality of risk? It’s possible to statistically measure whether some decisions were wise. But in the real world, day to day, we simply don’t. It’s too hard. We prefer simple stories, which are easy but often devilishly misleading.
Someone else’s failure is usually attributed to bad decisions, while your own failures are usually chalked up to the dark side of risk. When judging your failures I’m likely to prefer a clean and simple story of cause and effect, because I don’t know what’s going on inside your head. “You had a bad outcome so it must have been caused by a bad decision” is the story that makes the most sense to me. But when judging myself I can make up a wild narrative justifying my past decisions and attributing bad outcomes to risk.
The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side.
The dangerous part of this is that we’re all trying to learn about what works and what doesn’t with money. What investing strategies work? Which ones don’t? What business strategies work? Which ones don’t? How do you get rich? How do you avoid being poor? We tend to seek out these lessons by observing successes and failures and saying, “Do what she did, avoid what he did.”
If we had a magic wand we would find out exactly what proportion of these outcomes were caused by actions that are repeatable, versus the role of random risk and luck that swayed those actions one way or the other. But we don’t have a magic wand. We have brains that prefer easy answers without much appetite for nuance. So identifying the traits we should emulate or avoid can be agonizingly hard.
Countless fortunes (and failures) owe their outcome to leverage. The best (and worst) managers drive their employees as hard as they can. “The customer is always right” and “customers don’t know what they want” are both accepted business wisdom. The line between “inspiringly bold” and “foolishly reckless” can be a millimeter thick and only visible with hindsight. Risk and luck are doppelgangers.
This is not an easy problem to solve. The difficulty in identifying what is luck, what is skill, and what is risk is one of the biggest problems we face when trying to learn about the best way to manage money. But two things can point you in a better direction. Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming. Or, just be careful when assuming that 100% of outcomes can be attributed to effort and decisions.
Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging of entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself.
Therefore, focus less on specific individuals and case studies and more on broad patterns. Studying a specific person can be dangerous because we tend to study extreme examples—the billionaires, the CEOs, or the massive failures that dominate the news—and extreme examples are often the least applicable to other situations, given their complexity. The more extreme the outcome, the less likely you can apply its lessons to your own life, because the more likely the outcome was influenced by extreme ends of luck or risk. You’ll get closer to actionable takeaways by looking for broad patterns of success and failure. The more common the pattern, the more applicable it might be to your life. Trying to emulate Warren Buffett’s investment success is hard, because his results are so extreme that the role of luck in his.
Bill Gates once said, “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” When things are going extremely well, realize it’s not as good as you think. You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your store around just as quickly. But the same is true in the other direction. Failure can be a lousy teacher, because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk.
The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor. But more important is that as much as we recognize the role of luck in success, the role of risk means we should forgive ourselves and leave room for understanding when judging failures.
Relatable
0 Comments