risk management

How To Take Risks Without Losing Your Shirt

James Clear — Wed, 07 Dec 2011 22:25:07 +0000

Link:

http://www.openforum.com/articles/how-to-take-risks-without-losing-your-shirt

"Entrepreneurs are natural risk-takers." I've heard that phrase more times than I can count ... and it is one of the great myths of entrepreneurship.

In fact, I've noticed that entrepreneurs—and business professionals in general—are usually terrible risk takers.

Now don't get me wrong, entrepreneurs are certainly courageous. They are willing to try a way of life that others are not, and I think that's why people assume that they are risk takers. However, risk isn't really the right word. Just because someone does something outside of the norm doesn't mean that they are doing something risky. And it certainly doesn't mean that they are good at taking risks.

Regardless of the situation, most risks share one thing in common: it's rarely the initial decision that dooms a business. Instead, our irrational responses after the initial decision are what turn regular risks into big failures.

In hopes of helping you avoid the pitfalls of risk taking, here are three suggestions for taking risks without going out of business.

1. Take a Long Term View

If you look back on many reckless decisions in business, they are often made because someone didn't want to miss out on an opportunity. The idea of a vanishing window of opportunity often drives us to make decisions we wouldn't usually make. For example, think about your typical bidding war. Often, we pay more than we want because we convince ourselves that "this is our only chance."

As the famous golfer Jack Nicklaus said, "Extremes never work for long." It doesn't matter whether you're talking about a golf swing or a business move, don't put yourself in an extreme situation because you took the short term view.

Opportunities have a way of presenting themselves over and over again. If you're patient enough to pass on the bad deals in the short term, then you'll usually find some excellent ones in the long term.

Of course, that's easier said than done because we often convince ourselves that the deal we see, or the risk we are about to take, is worth it. Which brings me to my next point...

2. Stop Fooling Yourself

Poor risk taking is often the result of irrational behavior.

We see an opportunity, and because we don't want to miss it, we convince ourselves that we should take the risk. We agree to bad terms, we convince ourselves to make excessive purchases, we choose a poor strategic direction ... often because we get wrapped up in the idea of one possibility and search for reasons to convince ourselves that we are making the right move. This can be especially true for entrepreneurs, who often become enamored with new ideas and possibilities.

Rather than getting wrapped up in the new idea or opportunity, you can avoid poor risks by viewing a range of possibilities for each and every situation. When you're leaning one way, stop for a moment and consider the other view point. What if you did the complete opposite? What would happen? Why would a smart business person not make the same move?

By considering a range of alternatives, you can help prevent yourself from making poor decisions because of irrational reasons.

3. Evaluate the Situation as It Currently Is

Just because something was the right decision three months ago, doesn't mean that it's the right decision today. Of course, that doesn't mean it's easy to change course.

Making the right decision in the moment often requires you to check your ego, ignore the previous time and effort that went into a project, and eliminate your emotional connection to the business. That may sound hard, but the results of unbiased decision making can be excellent.

Here is an example. As the story goes, former Intel CEO Andy Grove was debating with current CEO Gordon Moore about the future direction of the company. At the time, Intel was a company that primarily produced memory chips. They also built a small amount of microprocessors. The problem was that Intel was losing money because of Japanese competitors who were building high-quality memory chips at a fraction of the price.

Grove looked at Moore and said, "If we got kicked out and the board brought in a new CEO, what do you think he would do?" Moore answered by saying, "He would get us out of memories." That was the moment Intel decided to abandon the memory chip business and start making microprocessors. The rest, as they say, is history. Hidden in that small conversation is a very powerful message.

It took a remarkable amount of courage for Moore and Grove to abandon Intel's identity as a company. Despite the difficulty, the two men made the decision that was best for the company at that moment in time. That's the secret to successful risk taking.

Risky decisions can be made as long as they focus on what is best for your business right now. Conversely, if you jump at opportunities and convince yourself of their worth for irrational reasons, then you'll chase one bad decision into the ground ... and your business will come along with you.

This article is from James Clear of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

How Investing Drives Us Crazy: Lessons From a Trade

Carlos Portocarrero — Fri, 30 Sep 2011 10:24:16 +0000

Investing can be incredibly frustrating, even when you're doing things "by the book." I'm going to walk you through a recent trade I made using real money, pointing out all the things I did well. Unfortunately, even though I did everything "right," I still lost money on this trade. Let's take a look at what happened. (See also: 7 Common Investing Mistakes)

Starting Out: It's All About the Sentiment

I was convinced the shares of a certain tech company were headed lower. And since I love tech, I had read up on them and knew what was going on. I felt I could make a very strong case to put my money where my mouth was.

So I bought what’s called a bear-put spread. I bought five September puts and sold five September puts at a lower strike. It cost me $275, and it would make me $225 if the stock stayed under $30. At the time, the stock was around $31.

Monitoring Your Trade: Pay Attention

Right after I made the trade, things started to happen in my favor. By August 8, it was all the way down to $25 — good job, Carlos!

Then it climbed up past $35...and I got a little anxious.

And then came the curve ball — a huge tech company bought another big one, and rumors started circulating that the stock I was trading might get bought up as well, which I definitely didn’t see coming.

If you have money on a company, pay attention to every piece of news, even if it isn't directly about that company. Read everything.

If Things Change, Make a Move

This current situation was no longer the situation that existed when I put the trade on. Because of the rumor, my original sentiment no longer applied. At that point, I had two options: stick my head in the sand and do nothing, or get out of the trade.

So I sold out of my trade for a total loss of $70, including commissions. I felt bad losing money, but I was also proud of myself for being proactive and doing “the right thing.” I felt like I was practicing sound risk management, which made me feel like some investing hot-shot who knew what he was doing.

If the landscape changes, get out while you can. Don't let greed keep you hanging on to a trade that's gotten out of hand.

The Aftermath

I was feeling great about my "risk management" skills right up until expiration came around. With the stock at $34 the day before my trade was going to end, I almost stopped paying attention.

But earnings the day before had been a catastrophe and the stock plummeted all the way down to...$28. I would’ve made a profit of $225 if I would’ve held on to the trade. Instead, I was down $70.

Here’s a P&L Chart courtesy of OptionsHouse that shows what my trade did from one day to the next:

It went from being down $275 to making $225 — all in one day! Talk about being filled with regret...

Even when you’re right and do the “responsible” thing, trades can turn against you. All you can do is learn your lesson and move on to the next trade.

Disclaimer: I am an employee of OptionsHouse. LLC and the views and opinions expressed herein are my own and not those of OptionsHouse, LLC or any of its affiliated companies. This post is meant as an informational post and should not be construed as investment advice or a recommendation of any particular security or investment strategy. Any similarities between this hypothetical investment scenario and any actual investment results are unintended and purely coincidental.

This article is from Carlos Portocarrero of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

How to Get a Life: Consider the Worst Case Scenario

Craig Ford — Thu, 02 Sep 2010 13:00:12 +0000

There is something that drives everything we do.

Some actions are driven by love. Others motivated by hate. Money can get most of us moving. Some act based on their religious beliefs.

The Purpose Driven Life reminds us that some are motivated by FEAR. And I believe it. As a minister, I've had the opportunity to peer into the psychological depths of many people. I've seen their raw emotions. When the masks are removed, fear controls much of what we do. Fear poisons us until we are too paralyzed to act.

You are paralyzed by fear when …

You won't pursue a small business idea because you're afraid that it might not succeed.
Despite the encouragement of co-workers, you're afraid to apply for a new management position.
When you close your eyes, you dream about traveling the world, but you're afraid of what others will say.
You've always wanted to try out for the next dramatic production, but you're afraid you won't get the part.

In life, we are often afraid to do truly courageous things because of what might happen.

It might not go according to plan.
I might not make money.
I might lose my job.
I might not get the job.
My friends might not support me.

Today, let's learn one simple life hack that will allow you to really, truly, start living life.

When making an important decision, ask yourself, "What is the worst case scenario?"

Now, I'm not talking about psychological mumbo-jumbo where you try to convince yourself you can do things that you really can't. Nor am I talking about apocalyptic bad news where the worst case scenario is that aliens from another planet might come and eat you for dinner. Literally and logically, what is the worst case scenario that is likely to result from your actions?

Start Living Life Homework

Get a pen and paper and write one of your life goals or something you've always wanted to do at the top of the paper.
Then write this subtitle, What's the worst case scenario?, and list all the things that could possibly go wrong if you pursue that goal.
Write a number from 1 to 10 beside each listed item. Write a '1' if the worst case scenario is not really likely at all to happen. Write a '10' if it is almost certain to happen.
Now imagine that everything ranked 3 and up actually did happen. Would you regret your decision? Would you do it again?
If your answer is yes, then do it.
If your answer is no, start making whatever changes or adjustments are necessary so that you can soften the blow of a worst case scenario.

Case Study #1: Can mommy afford to stay home?

Sally and her husband, Greg, have a 6-month-old baby, and Sally really wants to stay home with junior. The problem is that they are afraid they won't be able to pay the bills if Sally stays home. If they were able to cut their spending and Sally could earn an extra $300-$500 per month, they would be fine. They have a reasonable financial cushion of $5,000 savings, but they are paralyzed by fear and afraid to do what they really want to do.

What's the worst case scenario?

Sally might not find a way to work from home. She might not like staying at home. The family might not be able to cut enough expenses.

So? If she stays home for six months and doesn't find something she can do from home, then she can just go get another job.

Cast Study #2: Start your own small business.

Tom has been slowly developing a computer software program. The program is selling well and providing a reasonable profit. He'd love to quit his full-time job and focus on building the business, but he's afraid. What if business doesn't pick up?

So, what's the worst case scenario? The business doesn't pick up and Tom is forced to go back to work and finding a part-time job.

Fear As Positive Motivation

For those who face this kind of fear, perhaps you can use your fear to your advantage. Take that fear and use it to help distance yourself from the perceived risk. Increase your emergency funds savings. Spend an extra three months working full-time and part-time to give more cushioning. Jumping off a cliff is very different from jumping off a curb. The less risk, the more likely you are to succeed.

Still, far too many people are driven by fear and let the world pass them by while they watch from the sideline.

Throwing caution to the wind is not the advice here. Typically, those who are the most fearful are those who are most cautious. They don't need to be encouraged to retreat further into their shells, but to take a risk to do what they love. If the worst case scenario is truly frightful, then don't do what you're considering. So, if the worst case scenario means your best alternative is declaring bankruptcy in two months and you'll lose your family in the process — don't do it. But many times, even if the worst did happen, we'd still be glad we took the risk.

Do you think this is good advice or just likely to cause a bunch of people to crash and burn? Is there anything you've been wanting to do, but you know it's just fear that is holding you back?

This article is from Craig Ford of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: