Risk Intelligence for the Layperson

If you intend to embark on a career as a gambler or a weather forecaster, or if you intend to speculate on the stock exchange or take a punt at your local horse races, improving your risk intelligence would stand you in good stead and improve your odds of winning. However, not everybody is interested in gambling or other ‘risky’ ventures, so why should you care about your risk intelligence?

In everyday situations, improved risk intelligence can be advantageous. Whether it be evaluating what insurance cover we might need, if we are a member of a jury, making business investment decisions, working in recruitment and employing someone with previous convictions and even whether or not to move in with a girlfriend/boyfriend, the ability to accurately assess the risks of each circumstance would leave us much more likely to get a positive final outcome. The layperson in particular exhibits three key flaws when evaluating risk:

1) Overconfidence – this is the most common flaw. It is when we are more confident in a particular outcome than we have reason or evidence to back it up with. Overconfidence is exceedingly common and often comes from those that we trust most to help us make decisions; experts. Relying on ‘experts’ is not always as simple as it might sound. Just because someone knows a lot about something, doesn’t mean they are aware of their limitations, of how much they don’t know. For evaluating risk, it is often more important to know what you don’t know, than it is to know what you do know. Therefore, by improving your own risk intelligence, you can evaluate how effective an expert is, how reliable their information is, and what risks you are taking to apply it to your own situation. The sort of experts that you would meet on a regular basis that would fall into this category would be doctors and other medical staff, and bank managers and other financial advisory staff.

2) Worst-Case Scenario Thinking – This is when we allow ourselves to be negative and make low-probability scenarios into near certainties, without any logic to back it up. It often creates with it a spiral of demoralising thoughts and even-worse outcomes, none of which are helpful for making a decision. It prevents genuine risk assessment and logical reasoning for a decision and often results in an emotive and poor decision. An example of this could be refusing medical treatment such as surgery to fix a badly-broken leg because of the risk of a low-probability outcome such as death. It can be very easy to become irrational and emotionally-involved and decide that opting for surgery will result in death and therefore it would be better to just live with a bad limp or inability to walk, the outcome of leaving the leg to heal by itself.

3) The Availability Heuristic: Imagination Inflation – estimating the likelihood of something happening based on how easily we remember it happening in the past. The illogicality of this can be seen by the fact that what we are remembering doesn’t need to have happened in real life, but we could have seen it in a film or a computer game. This can result in grossly inflated probabilities. It can also work the other way, with difficult to visualise scenarios being underestimated. For example, we could have been watching the film The Towering Inferno and the following week we come to renew our business’s fire insurance. Vividly remembering the burning building from that film, you are more likely to spend unnecessary money on more comprehensive and expensive cover than you actually require.

By being aware of these flaws and evaluating your thought processes against them when assessing risky decisions you can improve your risk intelligence and the general success of any risk-based decisions you make. Assessing how sure you are something is right or wrong, or is or isn’t going to happen, rather than simply looking at things from a black or white perspective as well as evaluating the outcomes of any decisions you take to improve on your thought process in the future will help you on your way to becoming a more astute risk taker.

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Jessie Hardcastle is a freelance writer from England who specialises in finance and investment for a number of UK journals and blogs. With a growing following she has recently be focussing mainly on the problems close to her London home as Europe continues to falter in the face of political indecision.