Learn / Part 4 · Protecting What You Have
What Risk Actually Means
What does risk actually mean?
In brief
Risk is the chance that things turn out differently from what you hoped, and in particular that you lose what you cannot afford to. It is not the same as volatility, and it differs for everyone.
Key ideas
Capacity, tolerance, need
How much risk you can afford, can stomach and need to take are three different questions.
Make an insight card →Probability and size
Rare large losses and frequent small ones call for different responses.
Make an insight card →Reduce, transfer, absorb
You can lower a risk, pass it to an insurer, or accept it.
Make an insight card →Try it
Insure or absorb?
Insurance is best at transferring losses that would ruin you. For small, affordable losses, paying the premium usually costs more than it pays back on average. Test a policy on both measures.
Open the full page: formula, variables, worked example and cautions →
Also relevant: Losses and recovery
Red flag
A product described as “risk-free” or “guaranteed” with no mention of who stands behind it.
Ask before you sign
- What is the worst plausible outcome, and could I live with it?
- Who bears the loss if this fails?
Do this week
Complete the Protection check.
Try it · 10–45 minutes
List the five largest risks to your finances and tag each: reduce, transfer or absorb.
Connected ideas
Where else this shows up
Pause and reflect
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Words worth knowing
- Risk
- The possibility that outcomes differ from what you expect, including losing money. Not the same as volatility.
- Expected value
- The average outcome of an uncertain event, found by weighting each outcome by its probability.
- Volatility
- How much an investment’s value swings. A measure of bumpiness, not of permanent loss.
Companion notes written for this website, based on the topics of Chapter 16. They explain ideas and do not reproduce the book. General information, not personal advice.