Do you want to reach your full potential? A big part of that, I believe, is managing your risks. There are risks in different parts of your life, and the better you manage them, the better your chance to move forward in life. Not managing your risks well, on the other hand, could cause you a big headache down the road.
I’m constantly learning how to better manage my risks, but I’d like to share what I’ve learned so far with you. Here are my four lessons learned on how to manage risks.
1. Always be prepared for the worst-case scenario.
A common mistake in risk management is ignoring the worst-case scenario. Many people are overconfident about the future, especially during good times. As a result, they ignore the worst thing that could happen. They simply assume that the worst would never happen.
But guess what? It takes just one such event to ruin everything. A recent example in the financial world is what happened to Archegos Capital. It used excessive leverage to grow its investment fast. The initial capital of $200 million in 2012 became $4 billion in 2017. Amazing performance! But, assuming that good times would continue indefinitely, it didn’t stop there. Instead, it took increasingly aggressive leverage. The capital became $20 billion in early March this year, a 100x (!) increase over the initial capital. But then the worst happened. Its portfolio went into a death spiral and the $20 billion was gone in just a matter of days!
Again, it took just one worst-case event to ruin everything. So be prepared for it.
2. Always have alternatives.
To put your risks under control, you should have alternatives. In Getting to Yes, a book on negotiation, the best alternative you have is called BATNA: Best Alternative to a Negotiated Agreement.
It’s important to have your BATNA prepared. Why? Because the better your BATNA is, the stronger your bargaining power. The worst position to be in is to have no alternative at all. In that case, the other party can dictate whatever they want and you have no choice but to say yes.
This applies not just to negotiation, but also to different parts of your life. For instance, you could have a side business as an alternative to your day job. When something goes wrong with your day job, it wouldn’t affect you too much because you still have your side business.
3. Make sure the alternatives are uncorrelated.
For the alternatives to really reduce your risks, they need to be uncorrelated. If they are still correlated, they could all go down when something bad happens.
For example, let’s say you have two income streams but both of them depend on traffic from Google. When something goes wrong with Google’s traffic, both of them will go down because they are correlated. You should instead build your second income stream in a way that doesn’t depend on Google.
4. Take higher-level risks.
When you manage your risks well, you will have a strong foundation to take higher-level risks. You can take new risks that will take your life to the next level.
For example, if your personal finance is well-managed, you can take the risk of starting your own business. You can afford the uncertainty because you already have a financial cushion.
Taking higher-level risks is important if you want to reach your full potential. Otherwise, you will just stay in a comfort zone. Moving to the next level requires you to leave your comfort zone and move to the unknown.
Don’t manage your risks with the goal of being comfortable; manage them to enable you to take higher-level risks.
These are four lessons that I have learned on managing risks. Any thoughts? Feel free to share them in the comments!
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