Is it a bad thing to be risk-averse?
This is a difficult question to answer because it presupposes a dichotomy of thought: you’re either risk-averse or a risk-taker. This either-or situation contrasts the management of risk too cleanly; either you don’t take enough of it, or you take too much of it. In this article, we will discuss the impact of being too risk-averse and why it is still good to stay away from some form of risk.
Systematic and non-systematic risk
In finance, there are two types of risk: systematic and non-systematic. Systematic risk is one which affects the whole system, is associated with the market, and is therefore inherent. So long as you are operating in the market, you will have to accept this risk. For example, if the PAP loses its mandate to run the government, all businesses in Singapore stand to suffer. This is a systematic risk for doing business in Singapore (indeed for any other country too).
Non-systematic risk is one which does not affect the system. It is more associated with a part of the market or system, and whatever happens to it, does not affect the whole system. For example, in 2003, the SARS virus almost wiped out several airlines because air travel as severely crimped. But it did not affect banking, or construction. These are non-systematic risks. So if a business were solely operating on this industry, it is assuming non-systematic risk. This risk can be diversified away by operating in separate markets or segments.
Hence, systematic risk cannot be diversified away and has to be assumed, non-systematic risk can be diversified away and should. And as in finance, so in business.
We are all risk-takers
To a large extent, all of us are risk-takers, so to call risk-taking the opposite of being risk-averse is not correct. If there were no risk, there would not be a risk premium, and hence, no businesses. Businesses take advantage of this risk, and the more successful businesses are more comfortable with the risk involved. Does this mean that risk-averse companies don’t make as much as risk-taking businesses? The answer is no. It again has to do with systematic and non-systematic risk, and which you are assuming.
It may pay to be risk-averse
To a large extent, successful companies have learnt either to mitigate their systematic risks, or to accept them. Accepting them requires you to work out your worst-case scenario and ensuring that you create good trigger points to pivot your strategy. Mitigating systematic risk means that you treat them as non-systematic by taking a larger point of view. If a business views its markets globally, having different geopolitical bases, it may be able to diversify regional systematic risks. And unless there is a global financial crisis quite like the one seen in 2010, this strategy can make our total risk lower. So while investing in one country is risky, investing in several different regions and continents is less so. We take more risks to lower our risk; sounds like an oxymoron? Yet it makes perfect sense, and so here, it pays to be risk averse!
A fine line between risk-taking and foolhardiness
If you cannot handle the downside, or if you cannot manage it away, stay clear! Do not be in, or prolong being in, a situation of high risk because the downside may well be much more than all your upside. Non-systematic risks tend to be this way. Different sectors of the economy have different risk, and if you choose to remain in one highly volatile sector, then you are playing with fire, and you might get burnt. There is a fine-line between being a risk-taker and foolhardiness.
There is nothing inherently good or bad about risk, it simply is. Risk is there if you do something about it, and it is there if you don’t. Not doing anything may sometimes be the best policy when it comes to systematic risks, and not doing anything may be disastrous with other non-systematic ones. There can also never be too much risk or too little risk. Risk comes with its rewards, and taking on more risk means you value the upside more than the downside. Being risk averse can also be good, as we have seen earlier, as it protects your assets while you diversify you exposure. Sometimes, the only answer to growth is by being risk averse!