Low Risk High Returns, High Risk No Return…

Most of us, either by instinct or education, generally perceived risk and returns in the form of probability.

Eg: Running across a busy road has a higher chance of meeting with an accident compared to running along the walkway of East Coat Park, and thus the former is deemed as a riskier activity.

But is it always the case?

I still can remember a particularly insightful line uttered by Mark Lee in a Jack Neo movie (the name I’ve since forgotten) years ago, In it, he said (paraphrazed), “The chance of striking 4D is 50-50.” When probed by his co-stars, Christopher Lee and Henry Thia (could have been Marcus Chin) on the basis for his theory, he replied, “Because either you strike, OR you don’t strike (thus 50-50).”

While we will laugh at such absurd notion, the truth is, that this kind of erronoeus thinking is more pervasive in real life than we can imagined, whether we realized it or not.

Let’s use another example: Again, a few years ago, I was trying to persuade a client to increase his critical illness coverage, which was relatively low for someone of his income and amount of liablities.

He told me, quite philosophically, that he needed some time to decide if it was worth paying the premium or take a gamble on his health. I could imagine his internal dialogue as, “What if I buy and nothing happen vs What if I buy and something happen?” A 50% probability assigned to each scenario.

It looked like a logical thought process on his part until one realized the more important question he failed to asked was , “What if I DIDN’T buy and something happen?” because what matters, in his case, was NOT the probablility but the IMPACT of both decisions. (he didn’t take up my suggestion eventually, despite my efforts in pointing out the asymmetry) 

Going back to Mark Lee’s quote again:

As most of us will already know, the chances of striking the 4D 1st Prize are pretty slim, but it will not make a significant difference to anyone’s pocketbook by just spending $3 every week on it (assuming the minimum bet and buying all 3 days).

On the other hand, if you are “lucky” enough to strike it, a $2,000-$3,000 payout could make you a happy person for quite a while.

And in the case of my thoughtful client:

Setting aside another $100 every month for the insurance will not land him in the poorhouse (if $100 is going to make a huge difference to your daily survival, then it REALLY is a problem), but by failing to isure himself adequately it could well wipe out his entire savings (not unheard of)  with a crippling medical bills as there is really no upper limit to such expenses, especially in Singapore. 

In conclusion, it is really the IMPACT and not the PERCENTAGES we should be looking at when assessing risk/ returns. 

The only professionals (if I can call them as such) I know who have a clear grasp of this fact are the bookmakers (bookies, in local lingo). That why the odds for football betting are adjusted every now and then, to eliminate the risk of a low-probabilty- high- impact event (like West Ham beating Barcelona 0-5 at Nou Camp) from bringing the house down.

PS: I am not advocating the buying of 4D. But if you are thinking of buying some insurance… you know my number… 🙂

 

Sep 11: A perfect example of a low probability, high impact event (before it happened).

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