Assessing your risk tolerance
David shares the framework he used to determine whether ETA was the right fit given his risk tolerance and long-term goals.
My life and risk
I view myself as a relatively risk-averse person. Though I may not hide in my apartment all day to avoid the dangers of the real world, I am continually assessing how I can maximize my ‘risk-adjusted returns’ in life. I wouldn’t say I like risk, and I don’t think many others do either. Living with uncertainty for long periods can severely strain our mental well-being, and we are seeing some of the effects of that coming out of this pandemic.
However, I observe a high correlation between uncertainty and personal growth if one can manage it properly. So here we have this paradox; uncertainty stresses us out but can make us stronger individuals. In assessing my risk tolerance, I always believe that more uncertainty keeps my mind strong and agile and may not necessarily mean ‘more risk’.
What do I even mean by the word ‘risk’? According to Merriam-Webster, risk is defined in four variations: the possibility of loss or injury, someone or something that creates or suggests a hazard, the chance of loss or the perils to the subject matter of an insurance contract, and the chance that an investment (such as a stock or commodity) will lose value. Since we are discussing risk related to search fund entrepreneurs, let’s align on using the last definition, where such investment is yourself.
Let’s play a game
I digress for a moment to demonstrate how abstract and subjective risk as a subject can be with a short mental exercise. Don’t worry. I will avoid any risk and utility models you may have encountered in various economics courses. Okay, now let’s begin.
I’m going to offer you a (hypothetical) deal. You get $10 with certainty or a 1% chance of receiving $1,000 and a 99% chance of receiving nothing. Take a second and think. What did you choose?
Now, let’s up the stakes. You get $1 million with certainty or a 1% chance of receiving $200 million and a 99% chance of receiving nothing. What did you choose this time?
In the first game, the expected outcome of each scenario was $10. You always receive $10 in the first outcome and an expected value of (99% x 0) + (1% x $1,000) = $10 in the second. If we are risk-neutral individuals, we would be indifferent between the two choices.
Keep reading with a 7-day free trial
Subscribe to Maverick to keep reading this post and get 7 days of free access to the full post archives.