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The Invisibility of Risk

– George Hadjia

Many investors in the stock market fail to delineate between a decision and its outcome. While the two might seem linked, it’s important to remember that there are alternative histories that could have played out and rendered a vastly different outcome. The invisibility of risk often makes this idea easy to overlook, but we should constantly remind ourselves of the many various outcomes that could transpire from a decision.

Nassim Taleb expands on this idea of alternative histories in his book Fooled by Randomness, arguing that the decisions individuals make should be judged on the possible outcomes that could have played out, not the outcome that did play out. In this sense, Taleb underscores an important point: a successful outcome might have occurred even though the decision was poor, and, vice versa, that an unfavourable outcome might have resulted from an optimal decision. But how can this be? Surely if the outcome was poor then the original decision was also poor?

Herein lies the problem of conventional thinking in light of an uncertain world where we can’t observe the alternative histories that could have played out: by conflating the decision and the outcome we can delude ourselves into thinking that the positive outcome was a result of our skill, rather than us just getting lucky.

If we take an extreme example of somebody playing Russian roulette with a six-chamber revolver, then there are two outcomes during each play. The first is that the person lives to fight another day. The second is… well, it’s probably self-explanatory to those familiar with the game. Let’s just say that the player plays a round and after pulling the trigger, avoids catastrophe. Does this mean that it was a good decision to play? Absolutely not. With one bullet in a six-chamber revolver there’s a one in six chance that your life ends in any given play. I would venture that for the majority of people here the risk is too great, and in this scenario the alternative histories are easily imagined.

Investing, however, is far more complex and random than a game like Russian roulette that has a set of defined and calculable probabilities. Regardless, investors must think about every investing decision through a mindset that tries to ascertain what the alternative histories could look like, accepting that some of these alternative histories are simply unknowable in the present.

George Hadjia is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

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