A Guide To Risk-Taking For The Risk-Averse

Let’s assume that a little under a year ago, you started a new business. You woke up this morning and were horrified to find that it has failed. What happened? What went wrong?

These are the first questions of what’s called a premortem, a popular business exercise, and the Harvard Business School case study. Businesses are supposed to conduct a premortem to find out what might go wrong about a decision they’re pondering (e.g., launching a new product, shaking up the organizational structure, etc.) and avoid potential failures before they happen.

Recently, I’ve seen a few authors and bloggers espousing the benefits of a premortem for individuals. Assuming your new side hustle failed or your move to a new city was a disaster, what went wrong? Armed with these insights, you can adjust your approach and improve your likelihood of success.

People in the financial independence community strike me as being pretty good at conducting these premortems in some areas of life. For example, what if I woke up penniless on my 90th birthday? What could have gone wrong? I could have:

• Spent nearly every dollar I earned while working
• Failed to save a sufficient percentage of my income to cover healthcare costs
• Been unwilling to invest my money in risk assets to grow my savings above inflation
• Relied too heavily on government programs (e.g., Medicare and Social Security) that may be diminished or nonexistent by the time I retire

With those things in mind, I would be more likely to save and invest prudently. In doing so, I would eliminate the most obvious potential pitfalls, significantly reducing the likelihood that I’ll wake up old and broke.

But this is just one area of life. Let’s consider a broader scenario. Instead of waking up penniless on my 90th birthday, let’s say I wake up on my 90th birthday and realize that I’ve wasted my life and mislived to a devastating degree. What went wrong?

If you’re like me, you had a few things pop into your head when you considered that scenario. Did you lament that you didn’t spend more time trying to build and cultivate strong relationships with your family (and perhaps having a family of your own)? Did you wish that you had done less pointless work for the sake of money?

These are just a couple of my hypotheses. The premortem flips the standard approach of lifestyle design on its head, making your priorities clearer in the process. It also highlights a few interesting things about risk that are worth exploring.

When we were growing up, things were either “risky” or “safe.” Riding a bike down my very steep driveway: risky. Playing baseball in my backyard with my dad: safe. Racing home to make curfew on suburban streets late at night: risky.

For most of us, our childhood years shape our attitudes toward risk. As I’ve gotten older, I’ve realized how little my concept of risk has evolved from the binary “risky or safe” system I lived by as a child. Many of my friends and colleagues are the same way.

Though all of us have some areas in which our concept of risk has pushed past this childhood system—for the FI community, this is usually saving and investing money—we could all benefit from a more nuanced understanding and treatment of risk.

Not All Risk Is Created Equal

What does someone mean when they say something is “too risky” for them? We encounter this objection all the time with people who don’t believe in the possibility of early retirement. When we dismiss their arguments as reductive or ill-considered, we often say, “Actually, it’s not risky at all.”

That’s not strictly true, though. There is risk in early retirement, just as there’s risk in investing in index funds or real estate. What we’re saying when we dismiss their understanding of risk is that the risk they write off as Bad Risk is Good Risk.

What constitutes Good Risk versus Bad Risk?

A Good Risk is a risk that either has a high probability of the desired outcome or will deliver palatable side effects even if it doesn’t pay off.

A classic example of Good Risk is a steady investment in index funds. If history repeats itself, you’ll almost certainly end up far wealthier for doing so. If not, you’ll likely beat inflation and will be better off than if you stayed in cash.

Another example is building a side hustle. If you pick something that will develop valuable skills or helps you make connections with interesting, like-minded people, you can succeed in your side-hustle even if you don’t make much money. Moreover, because you aren’t launching a full startup, your financial cost is low, and your downside risk is limited.

On the other side of the coin is Bad Risk. These risks have a lower (or no) probability of payoff and have uncapped downsides (i.e., your potential for loss is theoretically unlimited) if things go wrong. They also carry adverse side effects if they do work out.

Some examples of Bad Risk are apparent. We shouldn’t run out into traffic when cars are coming because we’re running late for a meeting. Our upside (being on time) is far lower than our downside (arriving at the meeting dead). Nor should we put our entire personal wealth on 00 at the casino. The probability of payoff is far, far too low.

Some Bad Risks are less obvious, though, and more insidious. Not taking care of your teeth is a virtually guaranteed path to pain later in life. Avoiding physical exertion in favor of a sedentary life is similarly likely to deliver you a bad outcome. The immediate payoff of not exercising or flossing is limited to a few minutes of slightly higher comfort; the downside is being prematurely old and unable to function normally.

For the most part, people agree on what falls into the Good Risk and Bad Risk buckets. Sure, everyone has different risk tolerances, and there are very few Good Risks for the highly risk-averse person. But by our nature, those of us in the financial independence community are open to some risk.

Our task, then, is to determine which risks to take within the Good Risk bucket.

Examining Good Risk

Avoiding Bad Risk is an excellent start toward a prosperous life. But we can’t take every risk that we’ve classified as “Good,” trusting that things will work out. Within Good Risk, we must determine what’s worthwhile risk and what isn’t. When does it make sense to dial up risk intelligently, and when should we pass up the opportunity?

Intentionally increasing exposure to market risk is what we do by allocating money to index funds. Most of us firmly believe that this is a worthwhile risk. For most of the FI community, this is a well-executed Good Risk.

But what about your career strategy? If you’re like me, you see your career as a block of time during which you rapidly accumulate and invest money, followed by a period of retirement. During the career portion of your life, you might be working on things you like doing or you might not. Many an engineer or financier has developed an interest in financial independence after discovering their jobs to be drudgery.

Once we’ve accumulated the requisite cash, many of us struggle to pull the trigger and jump to a financially free life. How many of us wait the proverbial “one more year” before making the jump out of full-time employment and into early retirement, seeing the choice as an all-or-nothing endeavor?

But paid employment isn’t an all-or-nothing endeavor. The Fioneers have made a compelling case for SlowFI, which they believe represents a golden mean between a supercharged career and full retirement. With SlowFI, you might take a more leisurely, enjoyable path to retirement. It would take more time, but your quality of life would be higher along the way.

If you find your day job to be stressful or unfulfilling, downshifting before retiring is an excellent example of a worthwhile risk. Staying at a job that’s sapping your life force in exchange for money is Bad Risk. You’re locking in a negative life experience in exchange for money that you could earn through other means.

If you’re like me, testing ways to enjoy your career more now—looking for jobs that might be less stressful or more fulfilling—is a worthwhile risk that you’re not fully embracing. The same thing goes for your free time. On the path to whatever version of financial independence you choose, you should be taking steps today to increase your satisfaction with your free time.

On the other side of the equation is Good Risk that isn’t worthwhile. There’s a high likelihood that I would learn valuable skills and make some money if I dedicated 25 hours a week to a new business venture. However, it might take me away from my family and friends, decrease my writing time, or cause me unwanted stress. That’s why I’ve decided that an entrepreneurial pursuit is, while a Good Risk, not one that’s worthwhile at this point.

Determining what’s worthwhile and what isn’t is a matter of personal preference and priorities. The question is less about the characteristics of the risk and more about opportunity costs. A 22-year-old with a 9-to-5 job and lots of free time might find it more worthwhile to start a company than I do as a 29-year-old with a demanding day job and fulfilling hobbies. A parent of three small children will view the opportunity differently than either of us.

I’ve found that while I’m great at identifying and taking risk in some areas, I’m very risk-averse in others. When I behave in risk-averse ways, I’m almost always conflating Good Risk and Bad Risk or failing to distinguish between worthwhile and not worthwhile risk. This confusion leads me to avoid acting on essential things in life that I’ve mislabeled as risks not worth taking.

A careful review of the situation, however, often reveals that the cost of inaction exceeds the risks of failure.

Recognizing The Cost Of Inaction

Inaction is easy. It’s inertia. It’s the status quo. The way things are isn’t so bad, right? Why upset the apple cart for a crazy risk?

But, as we’re quick to recognize while looking at the average career strategy, the risk of inaction is often higher than that of action. The tricky part is that it doesn’t feel that way. That’s why we stay in jobs that are unfulfilling well beyond when we should quit them. It’s why we don’t try new things, meet new people, or go to new places.

Let’s consider a typical example for many of my friends: You’ve gotten to know an awesome person and have developed romantic feelings for them. It seems like they might be interested too, but you’re not sure. Do you tell them how you feel? Do you put yourself out there and face the possibility that they might reject you?

Telling the person about your crush could lead to a strong partnership and a lifetime of happiness, or it could lead to them laughing in your face, which feels like an emotional kick to the nether-regions. So we don’t do it.

But the upside is so enormous that the right move is almost always to talk to the person. Having that uncomfortable conversation is Good Risk and highly worthwhile. Yet how many times have we all failed to work up the courage to take this worthwhile risk?

Inaction is more comfortable and, on its face, less risky, so we often choose that path. But inaction is Bad Risk in disguise. You have limited upside (you probably won’t get laughed at), and your downside is unlimited (you might miss out on spending your life with this fantastic person).

The cost of failure—of taking a chance and coming up empty—is easily imaginable. The cost of inaction rarely is. Like the most dangerous Bad Risks, inaction isn’t an all-at-once thing. It seeps into our lives bit by bit. Because it’s hard to envision what might have happened if you took the risk, we don’t know what we’re missing.

The same principle applies to other areas of our lives—interacting with loved ones, taking a chance on hobbies, or changing where you live. Inaction is easier, so it often wins out over worthwhile risks.

How can we loosen the grip that inaction has on our lives? It comes back to reframing risk, and we’ll use the premortem to do so.

Taking A Different View Of Failure

The conventional view of failure is trying to start a business that crashes and burns. Of course, this was a Bad Risk; you lost money and faced embarrassment in front of your friends and family. It’s also the romantic failure we imagined above. You work up the courage to ask someone out, and they say no in such a way that it becomes clear they have no interest in you whatsoever.

This surface-level view of failure is one I’ve carried with me for most of my life. Even now, it’s my default setting. In studying my behavior and the behaviors of others, there are only two real failures, regardless of results:

1. Taking a Bad Risk that presents capped upside and nearly unlimited downside
2. Not taking a worthwhile Good Risk that has significant upside and a capped downside

Bad Risks are usually easy to avoid. Don’t abuse drugs and alcohol. Take care of your body and mind. Don’t choose a career that will grind you down or stay in one that’s destructive to your health and happiness. Be kind to people. It’s simple advice, and I’ll assume that most of us have it covered.

The avoidance of Good Risk is the one that has the potential to generate regret down the line, and this is the one worth reframing. Inaction doesn’t feel like a failure at all. It feels like the easiest way to avoid failure, so how can we rewire our minds to take the proper view?

That’s where the premortem comes in. Let’s revisit the hypothetical I set up at the start of this post. You’re sitting in bed looking back on your life, and it’s been a failure. There will probably be things you wish that you hadn’t done, but what about the things you wish you had done? What risks didn’t you take that you should have?

There are a few obvious areas of life worth exploring.

Work: Did you work too much on things that weren’t fulfilling to you? Conversely, did you work enough on things that you found rewarding? Did you find something that you could do nearly every day that brought you happiness?

Family: Did you spend enough time with your loved ones? When you were with them, were you fully present? Did you make sure to express how you felt about them while there was time? If you wanted a family of your own, did you do everything you could to have one and prioritize it?

Relationships: Did you seek out a life partner who shared your values? When you found one, did you treat them well and work at strengthening your relationship? Were you strict in reining in your bad behaviors and lenient in dealing with theirs?

Health: Did you protect your physical and mental health to the best of your ability?

Hobbies: Did you seek out things that were interesting to you and delve into them? Were you engrossed in something outside yourself or engaged in a lifelong pursuit of knowledge in a specific field?

Your mileage may vary with each of the above. But if you do a premortem on your life at the macro level, you’ll find interesting things worth drilling into in each of those buckets. I’m willing to bet you’ll find something you’ve been putting off or to which you haven’t paid enough attention. There might be something that you’ve misclassified as a Bad Risk that’s an uncomfortable Good Risk.

Though the idea of picturing yourself as an old, regretful person can seem morbid, it’s the most effective device I’ve found for correctly framing the risk of failure. Failure is not taking a Good Risk and having an adverse outcome, it’s deciding not to take the chance at all.

Most of us probably aren’t taking enough Good Risks. As a species, we don’t give a new hobby an earnest shot, start a side hustle, or talk to the potential romantic partner nearly often enough. If we did more of this, we would live better, happier lives in the present and minimize our risk of becoming that old, regretful person down the line.

That’s the real danger of inaction. As Lao Tzu said, “If you do not change direction, you may end up where you are heading.”

In some areas of life, you’re likely right on track. But we all have blind spots, pieces of our life we choose to ignore. Give your life a thorough once-over in the coming weeks. It may even be worth conducting a premortem on yourself. Pay special attention to areas on which you don’t usually dwell.

Where can you least afford to end up where you’re heading? What can you do to change it?