What’s Reasonable Anyway?

By The Advocates

One of our clients has a tag line in their email signature that’s been there for years. It reads something like “Safety Third, google it”. I extend my apologies to this person as I confess that, until a few weeks ago, I failed to google it.

Our newest advisor, Chuck, asked about it and thus reminded me to look into it. I’m glad I did. For one thing, I really enjoy Mike Rowe’s voice. And he offers a different perspective on risk and safety in this video interview, which ends hilariously with a mock blooper of Mike directing stock trades.

His general point is that mindless compliance with safety standards may inadvertently create a culture of complacency, ultimately allowing us to outsource common sense and personal responsibility.

Case in point: a safety officer that made him wear a harness on a low-level platform (because it was going to be televised) when the length of his safety rope was longer than the drop from the platform, preventing exactly zero injuries, perhaps creating an unnecessary tripping hazard.

Look, I’m the Chief Compliance Officer at The Advocates and I winced every time he mocked my counterparts in other industries. But he does have a point, enough of one to make me think about the risks we take and why we deem certain risks “reasonable”.

Financial planners typically think about risk in two ways: covering certain risks that could cause your plan to fail, like loss of income or death of a spouse, with insurance when self-insuring isn’t viable and, how aggressive you need be in your investment allocation in order to have a successful plan. We call the latter your risk tolerance. That’s what we’re talking about today.

Once I finished my “Safety Third googling” (and watched the compilation of cold opens from The Office that auto-played afterward; I cannot resist), I searched for Morgan Housel’s thoughts on risk and came across this post, far darker than his usual stuff. For the record, I’m a fan of Mr. Housel and his widely acclaimed book, The Psychology of Money and regularly look for his input.

He walks us through the day he lost his two best friends, who decided to ski “out-of-bounds”, past the resort’s demarcation of safety. Morgan had done it too, that is, skied out-of-bounds, with them that morning. While doing so, they experienced a small avalanche which didn’t deter his friends from wanting to return later in the day. Morgan declined, for no particular reason, not to go on the second run with his friends. He never saw them alive again; they perished under six feet of snow in an avalanche in the out-of-bounds area.

We could chalk their deaths up to a failure of personal responsibility and we wouldn’t be wrong. They were old enough and experienced enough to know better, theoretically. They were informed, as the resort marked unsafe areas, and mother nature even fired a warning shot with a minor avalanche in the morning. It was a terrible confluence of arrogance and tragedy that cost them their lives.

Another viewpoint may see their choice as reasonable. Consider that they were young, strong, and experienced and had each other if one should be hurt. The only avalanche they had experienced was pretty non-threatening, Mr. Housel even likened it a rollercoaster ride. If they perceived the ultimate danger, the odds were low. But in the end, the odds didn’t matter, only the outcome.

Your risk tolerance is how willing you are to pay the price of negative outcomes. Mr. Housel offers these three sides of risk to consider while you determine your willingness:

  • the odds something bad will happen,
  • the average consequences if it does, and
  • the worst-case scenario: he calls it the “tail-end consequence”.

The last, he says, is all that matters. You can understand why. Your life’s experiences inform your ability to tolerate risk, perhaps more than any other factor. Mr. Rowe experienced bad outcomes stemming from overzealous safety standards because they allowed him and his crew to let their personal guards down. Mr. Housel, however, would probably view a safety zealot differently having witnessed the devastation of the ultimate price.  

The truth is that some people accept risks they shouldn’t without really considering the severity of really bad outcomes. That’s not good. But living in metaphorical bubble wrap isn’t the answer. We can’t predict or avoid all bad outcomes, no matter what. As planners, here’s what we believe.

Most clients have to assume some risk to create an acceptable probability of success for their financial plans. The more conservative Mr. Housel says he invests in generally safe index funds, he doesn’t keep cash in a coffee can buried in the backyard.

But we don’t suggest taking more than is reasonably needed. That’s because it’s unwise to bet the farm on anything, lest you end up homeless. Investors engaging in unnecessarily large risks need only look to history to know how fast it can all be washed away.

Its important that we get the real scoop on our clients’ real risk tolerance. Using it, we can put “guardrails” in place in your portfolio and financial plan overall that will help you voyage toward your vision for the future with as little turbulence as possible.

Got some risky business going on? (Sorry, we had to.) Schedule an appointment today to see what it could mean for your future.