The Nature of Risk

Many people feel their life is vanilla bland. Average. Nothing special. It’s not their fault. Humans are naturally risk-averse. Back when our ancestors were roaming the savanna, risk aversion allowed our ancestors to survive. But now, the fear is holding us back from reaching our potential. In today's world, with the accelerating rate of technological innovation, risk-taking is rewarded. Yet, our ancient brains make it hard for us to understand the very nature of risk.

So, what does this mean for students and their families? It means that many students follow a cookie-cutter formula: volunteer a certain number of hours, play at least one sport, be in at least one club, get good grades, and get good test scores. In the end, they become cookie-cutter products. Remember, humans are naturally risk averse. Add societal, familial, and peer pressure, and viola, you have copies of the same student.

If you are one of these students, you may ask “Ok. Yes. I see it. But how do you suggest I stand out from the crowd? I think the answer lies in finance, a field far removed from education. The dynamics of an investment highlight the nature of risk and reward the best. Just because you spend more time or energy on a position, project, or investment, it does not guarantee that extra input will result in a proportional outcome. For most people, you work more hours, you earn more money. You work 8 hours at a rate of $28 per hour. That’s a total of $224. Work 2 more hours? You will earn $56 more, totaling in $280.

Investments don’t operate under this principle. Finance rewards what works, specifically what works most efficiently and effectively. Say you put $1000 into stock X the day before the earnings are released for the previous quarter. Stock X outperforms during the earnings call, beating revenue and EPS (earnings per share) estimates by 25%. Then, investors pile into the stock due to the fear of missing out, and the price moves up 150% during trading hours. Your bet of $1,000 made $1,500, and that happened in less than a day’s work.

Exponential and linear growth compared. As you can see, there is an area in which the exponential line is below the linear line. This is the range in which many people quit.

The logic of asymmetric returns is what baffles most of humanity. How can someone earn more than what he or she puts in?

Well, the story of bitcoin can illustrate why this happens. Bitcoin is now 14 years old. Say you took a gamble and invested during its infancy (2009-2016). At that early stage, it was a much riskier bet to put money into BTC than it is now: the space was less developed, there were fewer users, no institutions had holdings, etc. Yet, you would have reaped video game-like returns. If you bought BTC in 2016, you would be up 62.5x or 6,150% if you held till now. If calculated annually, you would have gained 1,025% per year. If you put $5,000 into BTC in 2016, you would have $312,500, enough for a down payment for a single-family home in San Francisco.

Sure. You could have lost the entire $5,000 bet, but if you are a risk averse, and you most likely are, you lost the opportunity to make $312,500. That is the opportunity cost. Even if I use expected value to calculate the value of the bet, you would still be up. Let’s assume the chance of BTC succeeding from 2016 is 5%. Inversely, BTC has a 95% chance of failure. That’s high risk. $307,500 x .05 = $15,375. Let’s compare this to the risk profile of investing in the S&P index. Let’s assume the index has a 40% win rate. $5,718.60 x .40 = $2,287.44. Clearly, investing in the risker bet nets a bigger win. Any way you look at it, I would make this bet 100 times out of 100 times.

This hypothetical choice clearly demonstrates the conflict between our risk-averse psychology and math. Our instinct tells us to choose the safer red option. The math clearly tells us to pick the green option. The expected value of the green button is $25,000,000. The expected value of the red button is $1,000,000.

What about making other bets during the same period? You could have pursued a more conservative strategy by putting the $5,000 in the S&P 500 index. Since 2016, the index averaged 15.1% per year or 143.72% over 6 years. Compare this to BTC’s 6,250%.

Now, don’t focus on Bitcoin. The point of this writing is not to give investment advice in a particular position. BTC is not the only asymmetric bet out there. Before, there was Facebook. Before that, there was Apple and Google. And even before there were bonds and commodities. My point is: there is always a seemingly risky option out there that you can invest and receive an outsized return.

Ok, ok. You might be wondering what this has to do with education? The educational game has the same risk and reward dynamics as investing. You can take a conservative, safe approach like investing in the S&P. Or you can take a risk and do something different and unique. Of course, this sounds like a piece of cliché advice. And it is, but how many of us follow this generic advice?

A few. We don’t want to take a risk and do something different. Besides being risk-averse, we tend to shy away from being different from our friends and family. Again, this urge to fit in comes from our evolutionary past. Conformity kept you alive. If you were banished from your tribe, you would be dead within a couple of weeks from a lack of food or water, the elements, or a predator. So, it’s not surprising to see so many high school students volunteer x number of hours, join one club, and play one sport.

If you can break away from the mold, you have a high likelihood of being handsomely rewarded.

Let’s look at one anecdote. There was this one girl who decided to do ballet and modern dance. In her pursuit, she got into the American Theater Dance Workshop and Usdan Center for the Performing Arts. In addition to pursuing these super competitive disciplines, she took up acting. If you were her mother and father, you may have advised to tamper her hopes on a prosperous career in acting and the arts. Well, this young lady decided to audition for the off-Broadway musical Ruthless. She kept at it and landed a role in a Hollywood film. In 2000, she got into Harvard where she studied neurobiology, Hebrew literature, and psychology. Even after graduating, she continued her acting career and found leading roles in movies like Closer with stars like Julia Roberts, Jude Law, and Clive Owen. This lady is Natalie Portman. Her career turned out just fine.

Portman’s case is not the only one. The pages of Forbes, Nature, and history textbooks are filled with those who risked and triumphed. I will leave you with this choice. You can choose the safer option and fade away with a life of mediocrity. Or you can choose the risker route and live a life in pursuit of something worthy. It’s up to you.