Part V · Chapter 11 · Ruin · lesson 5
The risk inventory
12 min
Builds on The bet you must not take twice
Part V · Chapter 11 · Ruin · lesson 5
12 min
Builds on The bet you must not take twice
Ask someone what their financial risk is and they will usually name one thing: the markets.
The markets are on the list. They are one of seven, they are the one that gets written about daily, and for most people they are not the one that would do the damage.
The other six are quieter, and being quieter is the entire problem. A risk you have never named is not being managed. It is being carried.
A risk inventory is a list of the specific ways your position could get materially worse, written down before any of them happens.
The point is not to predict. It is to convert a vague background dread into seven named items, because a named item can be sized, priced, transferred or deliberately accepted, and a dread can only be felt.
Most of the list will end in the column marked carry. That is a decision too, and it is a much better one when it was made on purpose.
Career risk. Your income stops, or shrinks, or stops being worth what it was. Redundancy, a health event, an industry contracting, a skill becoming common. For most people under fifty this is the largest single risk they hold and the one least often written down, because income feels like a fact rather than a position.
Market risk. The things you own fall in price at the same time. Widely discussed, genuinely important, and mostly survivable if you are not a forced seller — which is a condition about your cash and your obligations rather than about the market.
Business risk. Something specific to one holding goes wrong. A competitor, a key person leaving, a customer concentration, a regulator. This is the one diversification is actually good at, and the one people most often decline to diversify because they feel they understand the specific thing.
Inflation risk. The number stays the same and what it buys shrinks. It has no dramatic day, which is why it is underrated: nothing ever happens, and then a decade later the money is worth a fraction of what it was.
Liquidity risk. You own enough and can reach none of it in the week you need it. This one converts other risks into losses — it is why market risk becomes permanent for some people and a bad year for others.
Fraud and theft. Somebody takes it. Investment fraud, account compromise, a trusted party who was not. Low probability, total severity, and almost entirely defended by process rather than by judgement.
Catastrophe. A house fire, a liability claim, a long illness, a legal rupture. Rare, unrelated to markets, and capable of removing a decade in an afternoon.
Predict
Each item gets two rough judgements and one decision.
How often, roughly? Not a probability to two decimal places. A band: most years, some years, once a decade, once a lifetime, never so far.
How bad, if it lands? Also a band, and this one matters far more: annoying, painful, a setback of years, or the end of the position.
Then the decision, and there are only four available. Avoid it — do not take the position at all. Reduce it — make it smaller, or make yourself more robust to it. Transfer it — pay someone else to hold the tail, which is what insurance is. Carry it — accept it knowingly, because the cost of the other three exceeds what the risk is worth.
Not the same thing
How often the event happens. The dimension people naturally reach for, because it is the one experience teaches.
How much damage the event does if it lands. The dimension that decides whether you are still here afterwards.
Which is which? Put each one on a side.
A month where the spending exceeded the income
A long illness with no income during it
A holding falling by a fifth over a year
Discovering that a trusted party moved the money
Do the exercise on a real position and the same shape usually appears.
The high-frequency items — a bad month, a bad market year, an unexpected repair — turn out to be things a reserve handles, and they occupy most of the worry.
The high-severity items — the illness, the liability, the fraud, the one concentrated holding — occupy almost none of the worry, are individually unlikely, and are the only ones capable of ending the position.
Attention is allocated by frequency. Damage is allocated by severity. Closing that gap is most of what the rest of this track is for.
Check
Kept in your head, the list rearranges itself to match your mood. After a bad week in the news, market risk is enormous and fraud does not exist. After reading about a fraud, the opposite.
Written down, it stops moving. You can also date it, which turns it into something you can be wrong about — the item you dismissed in year one and the item that actually arrived in year four are both on the same page, in your own handwriting, and that is the only feedback this domain offers.