The Problem With Probabilities
What influences our perspective on risk? In finance, risk is often determined by calculations based on historical data and empirical observations. However, the way risks are manifested in our heads is far different from how a computer will interpret them.
If you have ever been fortunate enough to swim in oceans around the Caribbean or Australia, the thought of a shark may have popped into your mind. Yet, you may not have considered the risk of sitting under a coconut tree, the malaria-carrying mosquito or the possibility of deep vein thrombosis brought on by a long-haul flight. All with more probability of killing you than a shark.
Humans have hard-wired evolutionary traits which used to increase our chance of survival. However, now that survival is no longer a daily challenge for us, these same traits can be more of a hindrance than a help. Even the involvement of cold hard numbers rarely helps, particularly if these numbers are presented in an unhelpful way.
We have a clear, recent example of our confusion with the extremely rare possible side effects of some of the Covid-19 vaccinations. Latest estimates on the BBC suggest that the risk of dying from the vaccine due to blood clots is 1 in 1 million, similar to the chance of being murdered or dying in a road accident1.
Life is full of risks, but as emotional beings, it can be hard to frame them correctly in our minds. We take risks every day without batting an eyelid. Driving, using ladders, drinking alcohol, climbing mountains, and walking through fields of cows (nearly 100 people were killed by cows between 2000 to 2020)2 are just a few. Yet other exceptionally low risks we deem ‘too big’ to take.
It is similar with investing. Investors tend to worry about equity market crashes. Yet, owners of equities should not be looking to sell them in the next few years but relying on cash deposits to meet liquidity needs.
With investment horizons well beyond regular falls and recoveries, investors who stay the course should be rewarded, as they have been in the past, with strong returns above inflation. Avoiding equity market risk and putting money on deposit is the risky strategy. Over the past 10 years, those holding cash have lost around 1/5th, or 20%, or £20 in every £100 of purchasing power, according to the Bank of England, one-month Treasury bills.
Risk surrounds us. We just need to keep perspective and not be put off course by numbers used in unhelpful ways.
Risk Warnings
This article is distributed for educational purposes. It should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm. It does not represent a recommendation of any particular security, strategy, platform or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
This article was produced for educational purposes and aimed at UK residents.
1https://www.bbc.co.uk/news/explainers-56665396
2 UK Health and Safety Executive (HSE) https://www.hse.gov.uk/
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