Adjust Accordingly

Everyone has a different level of risk tolerance. While I think there are extremes in either direction that are probably unhealthy, I’m sure there’s no exact correct level. What works for you doesn’t work for me, and that’s fine.

But what I notice is that people are often either extremely inflexible with their level of risk tolerance (leading to only even contemplating a very narrow range of behaviors) or they fail to adjust their behaviors when facing risk outside of their normal tolerance range.

Sometimes both!

Let me give you an example. Bob has a nice job at a mid-sized company making a reasonable salary. He’s good at his job and has a good relationship with his peers, so he isn’t especially worried about sudden job loss. As a result, he saves at a nominal rate.

Bob gets the opportunity to work for a much larger company at a much higher salary, doing largely the same job. He takes it because the raise is nice!

But here’s the thing: at the larger company, his job is less secure. He’s paid more, but larger companies make big decisions regarding their employee population based on many factors. Bob might be great at his job and beloved by his manager, but the company might have to eliminate 10,000 people as a business need and Bob might be one of them. The person making that decision doesn’t even know who Bob is. Any way you slice it, Bob’s job is less stable, even though he makes more money.

That, by itself, might be a fine trade-off! Like I said, everyone’s risk tolerance is different. But you want to know what I’m pretty sure Bob didn’t do? If Bob made 40% more money working for that larger company, I’d bet that Bob didn’t take that extra 40%, drop it immediately into his savings & investment account, and continue to live on the same take-home pay.

Nope. Bob took the higher salary, increased his lifestyle accordingly, and didn’t adjust his risk mitigation strategy at all. Now he’s in a risker position and he has more to lose.

That’s what most people do! They settle into a particular balance of risk/reward, and then if they see an opportunity for a higher reward, they don’t pay attention to the increased risk – especially if that’s the order. People are good at spotting “if I increase my risk, I might increase my reward” scenarios. They’re bad at spotting “my reward is increasing, which likely means increased risk in some way” scenarios.

The lesson here is not to avoid ever going for more reward. It’s that you can go for more reward even with the same level of internal risk tolerance as long as you adjust your risk mitigation strategy accordingly. You don’t have to constrain yourself to one narrow set of behaviors because you have multiple levers you can pull to keep the total risk level constant. You just have to adjust accordingly.