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“Risk is what you don’t see.”
– Morgan Housel
I recently had an opportunity to interview Morgan Housel the award-winning author and partner at The Collaborative Fund. He’s the author of New York Times bestsellers The Psychology of Money and Same As Ever. His books have sold over five million copies and have been translated into more than 50 languages. He shared his insights on risk, data traps, and how to be happier.
The biggest risks come from unknown, unpredictable events that, not only did nobody see coming, but were impossible to see coming, said Housel. He gave examples such as the attack on Pearl Harbor, 9/11, the collapse of Lehman Brothers, Covid pandemic and, more recently, the escalation of conflict in the Middle East. Each January, publications such as a The Wall Street Journal make predictions about what we can expect in the global economy over the next 12 months. Inevitably, the biggest risk or risks to hit the economy are not mentioned in the roundup.
“Risk is what you don’t see,” said Housel. “If you’re not thinking about a risk, you’re not preparing for it, and if you’re not preparing for it, it amplifies the damage when it comes. There is no formula or solution to get around the idea that risk is what you don’t see. People will ask, ‘What’s the next Black Swan?’ No, the whole point is that you don’t know when it’s going to be – that’s why it’s big.”
He shared two key recommendations for a healthier way to approach world events. One: come to terms with unknown risk. And two: Invest in preparedness, not in forecasting. “There’s a big difference between forecasting when the next recession will come versus having an asset allocation that will help you endure a recession whenever it comes. Expectations and forecasts are very different. So many of these things are the same as ever, and there are no solutions for them. You will never fix this problem.”
“We shouldn’t pretend that if we were born in Africa in the 1700s, we would have the same views on free market capitalism we have today. Our views are shaped by the dumb luck of where and when we were born. I believe in free will, but the majority of what we believe about the economy is based on personal experiences, our own and parents, grandparents. Everything about what we, as individuals, think about the economy was shaped by where, when, and to whom we were born.”
Housel recommends cultivating a sense of humility because so much of what happens in finance is avoiding overconfidence. “Once you have a greater sense of humility over how fragile the world can be, then you are much less likely to forecast things that are unknowable. Everything can be taken away from you in one second.” He gave the example of interviewing the Nobel-winning economist Daniel Kahneman who told him he was the biggest pessimist in the entire world. Housel was surprised to hear Kahneman describe himself that way until he explained that by growing up in a Jewish family in Nazi occupied France during World War II, the experience that, no matter how comfortable you are in the world, everything can be snatched from you in one second, had stayed with him his whole life.
“Luck is interesting,” he said. “It plays a major role in global economy, but it’s hard to talk about. A better way to think about it, is to ask, ‘what is repeatable’? When you think about your role models in finance, whoever they may be, it helps to be able to identify what they have done that is repeatable.
He gave the example of Warren Buffett. There is much to learn from him but no one can recreate the economic and trading environment of America in the 1950s when Buffett was buying up blue-chip stocks. “Always look for the skills that are repeatable,” advised Morgan.
According to Daniel Kahneman, the best definition of risk is what will cause regret in the future. That means that a good investor needs a very well calibrated sense of one’s future regret. Therefore, there is no singular definition of risk that fits everyone. According to Housel, Amazon.com-founder Jeff Bezos once said that he knew that if he started Amazon and it failed, he would not regret it, but if he didn’t start Amazon, he would feel regret.
“I’m different,” said Housel. “If I spent five years on a start-up and it failed, I would certainly regret it. Each of us has a different approach to risk. You can’t distill risk into a formula. If the issue is behavioral, then having better data doesn’t make much difference. There’s no Excel spreadsheet that is going to fundamentally change the amount of dopamine and cortisol you have in your brain.”
One of the most important life lessons for Housel is that most financial debates are about different risk tolerances and different time horizons with people talking over each other. He said that because finance involves math, it’s appealing to think there is one right answer.
“Most of finance is taught that there is one right answer,” he said. “We need to depart from that assumption, and doing so will make decisions easier. There’s advice for me that could be disastrous for you. Not everyone should have the same asset allocation. I’ve made certain finance decisions that a lot of my more intelligent friends would be confused. But these decisions make me sleep well at night and that’s sufficient reason for me. I’m an emotional person and so are you. We should come to terms with how personal, personal finance can be. You must know when data can be beneficial and when it can lead you astray.”
Life expectancy has risen for most people. Wealth has increased for most, too. There is better technology, better medicine, and fewer people living in abject poverty. Yet we don’t seem to be any happier for these improvements in quality of life. This is one of those things that is the “same as ever”, says Housel. “There is no solution for it because our expectations grow in lockstep with our prosperity,” he added.
True, at the poverty level, a rise in income, does correlate with increased happiness but for the average person the correlation does not work, Housel explained. “Americans don’t wake up each day because there is a polio vaccine. We are always moving the goal post. Listen, I want to live in a world where my grandkids have a cure for cancer. But the sense of joy will be brief as people come to expect it.”
Housel’s advice is simply to understand the game that’s being played and to identify the purpose of money in your life: Is it being used to live a better life or as a yardstick to measure yourself against your neighbor?
Amar Pandya, CFA, is Portfolio Manager of the Pender Alternative Arbitrage Fund and the Pender Alternative Special Situations Fund at PenderFund Capital Management.
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