Risk and Luck

2020 is an odd year. When saying so, we mostly mean that the experience we’ve had this year is beyond our expectation at the beginning of this year. We all have a model of life. We expect a set of inputs, i.e. our collective actions and external circumstances, to explain the output – how well we fair in life.

This year, many of our existing models broke down, or rather, explained too little. Our models of life have a very large error term.

While we can definitely reconstruct our models of life for a better fit, I think we all came to see that no matter how well we try to explain our lives’ outcome, the error term is likely larger than what we recognized.

This error term consists of Risk and Luck.

Difference between Risk and Luck

Here’s how I define Risk and Luck differently.

Risk: Events impacting our welfare negatively that objectively has greater than zero chance of happening. When they happen, the severity of the impact is huge.

Luck: That the Risk does not materialize within our lifetime

For example, before the emergence of the Coronavirus, all the public health experts knew there was a Risk of a pandemic that came from an air-born contagious novel virus that human has no immunity to.

It was Luck for some people to be born and passed away before the Risk became a reality.

On the other hand, now that Covid-19 pandemic continues, we all understand there is a Risk that if we contract the virus, we may die or have long-term health side effect.

Even controlling for all the known comorbidity factors, it is Luck that those infected did not die and fully recovered without lasting damage to their bodies.

How to react to Risk and Luck

It’s important to distinguish between Risk and Luck because they should promote different responses.

We should take Risks seriously. Taking Risk seriously means to prepare in proportion to likelihood that it will happen and the severity when it happens. It doesn’t mean that our preparation is always enough. We sometimes underestimate the probability and severity of some common Risks. However, at least we know not to depend on Luck.

Not depending on Luck doesn’t mean that we still experience it every single day. That’s why we should be grateful and humble every day because we don’t make Luck happen.

Again, how we act day-today right now amid the Risk of getting sick or dying from Covid is a perfect example. We prepare for the Risk by masking up, practicing excellent personal hygiene, social distancing and even isolating as much as we can. After all that, there is still a none zero chance of getting the virus. It doesn’t mean that we should just throw all the preventative measures out of the window because they don’t add up to 100% effective. It just means that we are continuously thankful for the blessing of staying healthy despite we cannot be 100% prepared.

Confusing Risk and Luck

What is dangerous is many people confusing Risk and Luck because they are both seemingly beyond our control.

This pandemic spread because many people think they are managing Risk properly even though they are just Lucky. We can spot the following thought patterns everywhere.

“This virus (Risk) is a hoax. I do everything the same and never got sick! (Luck)”

“The virus is not that lethal. (Risk) All my family got it and we all came out fine. (Luck)”

“The cloth mask is only 50% effective in blocking out the virus anyway. (Risk) As long as I don’t cough on people directly, I won’t spread the virus. (Luck)”

“I have flown a few times this year (Risk) and haven’t got sick (Luck), so the virus is probably not that contagious.”

Our response to the Risk of Covid has served as a good example of how we mistake Risk from Luck. It is by no means the only example. In fact, I think it just amplifies how much we try to ignore the controllable and control the uncontrollable in our decision making.

Prepare for Risk and recognize Luck

So how can we become better at preparing for Risk and recognizing Luck? Here are some steps to consider.

When things go well, consider the flip side.

Let’s say you invested 100% of your wealth in Tesla. If you had invested $100k in the beginning of the year at the low of the market, you’d have owned $1 million within a year.

Clearly you did not prepare for the Risk of the $100k becoming $10k. Recognize Luck was on your side and make future decisions accordingly.

When things go badly, incorporate new data.

Experience is a good teacher. It took two weeks of being uninsured for me to understand the negative consequence of having gap in health insurance. I wasn’t so Lucky like many who forego insurance for years without needing medical care.

I also had the experience of seeing my first single stock holding went from $70 to $0. This is why I will likely never invest 100% of my wealth in one company. I’d rather be prepared for the Risk than relying on Luck.

When nothing happens, learn from others.

The truth is that we can’t always rely on our own experience alone. We need to learn from our collective experience. That is why history is a better teacher. Continuing to enhance our understanding of Risks is the only way to prepare for them. As human, we easily discount things we haven’t experienced. Therefore, it is even more important to consciously go beyond our own experience so we can recognize the Risk did not happen to us due to Luck.

No matter how well prepared for Risk we think we are, we likely will never guard against all the unknowns. Nevertheless, the more we try to prepare, the more we will recognize the amount of Luck that exists. The reality is, as Covid-19 taught us this year, the error term in our models of life is indeed much greater than we give it credit for.