How much is too much risk to take?

Transcript:

Hey, humans! I’m Michael Liersch. This is the About Money podcast, presented by Wells Fargo. I’m a behavioral scientist with a PhD in cognitive psychology who loves openly discussing money to help humans better understand their money behaviors. By understanding our money behaviors, we all have the opportunity to make better money decisions.

In this season, we’re going to talk about how we can all sync up our life and our money. We call it LifeSync^®. You might be asking yourself, why does LifeSync matter? Well, when we align what we want to accomplish in life with our money, it can clarify whether money is truly working hard for us to get us to where we want to go. But that requires us to be intentional about what we want in our life, the jobs we want money to do for us, and compare it with how our money’s organized both now and in the future. To that end, we’re going to keep each episode under 10 minutes so that you can take immediate action to LifeSync. So let’s get into it.

In this episode, we’re going to answer the question: How much is too much risk to take? We’re going to play a game to kick things off. We are going to imagine that you have choices between two things: $20 for sure that you’re going to get right now from Michael Liersch, or you could say no to the $20 for sure, and we can opt to flip a coin. If it lands heads, you get nothing, $0. But if it lands tails, you get 100 bucks. So, think about this, your two choices: $20 for sure, or you could opt out, and you could go with a coin flip. Heads, nothing. Tails, $100. I want you to challenge yourself. What would you do and why?

The most important part here is why. So, if you take the $20 for sure, is it because you like sure things, is it because you know what you’d do with the 20 bucks, put it in your pocket, put it in the bank, you know, go buy a lunch, you know, whatever that is, is that why you chose the $20?

And if you went with the coin flip, 0 or $100, is it because $20 really wasn’t enough to make it exciting, so who cares if you got $0? Or is it because $100 is five times as much, and that sounds like so much more things you could do with it, it’s more exciting, and, again, no regret with getting 0? So, just the $100 looms large.

Or are you an economist and you say, well, the expected value, Michael, of the coin flip is higher. On average, I’m going to get $50. And that expected value that I’m going to get, so on average of that coin flip is dominant, or it dominates $20 for sure. So, that’s why. I’m an economist. I’m going to go with the coin flip. So, whatever your reason is, your rationale, choose, say why.

Now I want you to reflect on a new game. And we’re going to up the odds here. So, what if we changed it to 2 million dollars for sure from me right now? Or you could say no, no, no, Michael, I’m going to opt for the coin flip, where heads is nothing, $0, and tails is $10 million. So, again, $2 million for sure from Michael Liersch right now, or a coin flip: heads, nothing, tails, $10 million.

Now we want you to write down what you would choose and why. And what’s interesting here is when I play these games in big group settings, the majority of people choose the coin flip. And then when I change, though, the game to 2 million, right, up the ante for sure, or the coin flip of 0 or 10 million, suddenly the majority no longer want the coin flip and they change to $2 million. And suddenly all the reasons why they went with the coin flip in the first place, it was more exciting, $100 is five times as much as $20, the expected value, whatever it is, it falls to the wayside, and everyone says, well, I’d switch to 2 million because I can accomplish a lot with $2 million. I can achieve a lot of my goals with that. That’s a lot of money.

And so I’m highlighting this to you because when you think of how much is too much risk to take, one of the greatest factors that should be on your mind is whether you need to take the risk. And that’s the point of this game. Do you need to take the risk? And only you can determine that based on the jobs you want to get done with your money.

And that’s a really critical thing to evaluate. And oftentimes it’s difficult to evaluate on your own, so you need to trust a collaborator, an advisor, a spouse, partner, you know, people to talk about that. Do we need to take risk? Here’s how much money I want to have or I need to have based on the jobs I want to get done. Here’s the amount of money I have. And is there a difference in what I need to ultimately have to accomplish those jobs, like do I have less than I need to have to get those jobs done? Well, then perhaps risk essentially is required if you want to get those jobs done. Perhaps you need to, you know, lessen the jobs you want to get done, you know, lower the dollar amounts you need associated with them to create a better match. So, ask yourself, do you need to take risk?

The second one that’s really important here is do you have the ability to take risk? So, not only is risk required, but do you have the capacity or the ability to take that risk? So, while it may be exciting to take risk, or you may want to get more jobs done, and by putting your money at risk, you could potentially get those jobs done, you really need to think if you have the ability to do it. And that’s where things like diversification come in. You know, well, is there a way to then take risk in a more balanced way so that over a longer period of time you can get those jobs done?

And we talked a bit before about the magic of compounding, you know, money can grow in unexpected ways even if you’re very well diversified and grow your money quote unquote slowly, at least seemingly, initially over time, it can actually lead to outsized outcomes if you really have the time horizon required to get those jobs done.

So, is risk required? Do you have the capacity to take that risk? And in that framework, are you diversifying your risks so you can reliably get the jobs done that you need?

And then the last one here is what we hear mostly about, which is your willingness to take risk. Are my feelings driving me toward more or less risk than is actually necessary to get to what I’d like to get to with my money? And then on top of that, you have to think of the journey. So, many times, for people who don’t have a high risk tolerance, you know, when markets go up and down, that can feel very nerve-racking. And sometimes they exit the markets at exactly the wrong time, so they sell all their investments at a low point, and that can be really damaging to outcomes for a human being.

So, thinking about and being honest about your willingness to take risks can also help you think ahead and think about strategies in collaboration with others to keep you on course, even during times of stress, even if your willingness to take risk is low. On the other side of it, if your willingness to take risk is high, you’ve got to be careful on the other side, because as things go up, you might be tempted to throw more money at those very things that are going up, which sometimes can go right back down.

So, in that respect, you also need those core collaborators to keep you on course and say, well, actually, do you need to take those risks? And do you have the ability to do so? Are they appropriate with what you’re trying to accomplish? So, that’s how you could think about how much is too much risk to take. Do you need to? Do you have the ability to? And ultimately, is your willingness, is it getting in the way of really thinking about your need and ability to take that risk? And do you have a trusted collaborator that’s going to help you stay on course throughout your life so you can accomplish the jobs you want to with your money?

That’s it for this episode of the About Money podcast. Please email us with the topics that you would like us to address at AboutMoney@wellsfargo.com. And if you really like the episode, share it with family, friends, and anyone who listens to podcasts. About Money is produced by Wells Fargo. You can learn more about ways to work with us at wellsfargo.com/aboutmoney. I’m Michael Liersch, asking you to talk about money today.

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