Every day we take risks to get rewards but usually ignore our responsibilities, taking them as a given. For example, in the morning we make (or don’t make) decisions about what we are going to do. “Or don’t make” because there are things we must do such as go to work. At some point in the past we made a decision to accept a job and spend some of our labor capital to receive money capital for it – get paid. But we also accepted a responsibility to show up for work. If we do not show up for work our employer might fire us for not meeting our responsibility and record same in the slacker database. This could, in turn, make finding a new job most challenging. “What” you say, there is no such database. And my response is “yes there is,” there are many of them. And you are branded by them. What is your credit score?
To begin the topic more precisely, let’s begin with risk. In more simplistic terms, everything we do is “controlled”, collectively, by risk. The probability of an outcome is a value from zero to one. If the probability of an event is zero, it absolutely will not happen. If the probability of an event happening is one, it absolutely will happen. Assuming we can calculate it, in most instances, the probability of happening is somewhere between zero and one.
Let’s flip a coin. It is a two sided coin, heads and tails. It’s a perfect coin, being perfectly balanced and cannot be controlled by the flipper because it must hit the ground. The probability of the coin coming up heads is 0.5 with an infinite number of zeros following the five, or 50-50.
Let’s make it a little more complicated and look at dice. A die is a small cube, six sides, with a different picture or symbol on each side. Two die make a pair of dice, the devices used in the American game of craps. For completeness, craps is a simplified version of the western European game of Hazard and was brought to the United States in 1807 by a gambler. Let the side of each die have one to six dots so that when the two die (dice) are rolled the sum of the dots on the top will range from two though twelve. If you roll the dice and a seven or eleven comes up, you win. If a two, three or twelve comes up, you lose. If anything else comes up, you win by rolling to match it before a seven comes up. If you are playing against a casino and do the math, you will lose if you keep playing because the “house” has a 1.41 percent edge. This means the house will win 50.71 percent of the time while the gambler will win 49.29 percent of the games. Not much different than flipping a coin, but it has more “action.”
In these two simple examples we are looking at the probability of winning or losing. Let’s say the coin flip bet is one dollar and you are going to engage in the bet 1,000 times. In the coin flip, the expected value is zero, meaning that at the end of 1,000 flips you can expect to still have your dollar. Switch to craps and play $1.00 each time for 1,000 times. At the end you can expect to have lost $14.20. The expect value is a loss of 1.42 cents per each round of craps.
How long does it take to roll 1,000 rounds of craps? Let’s say it takes one minute per round or 1,000 minutes. That comes to 16 hours and forty minutes. Or you can expect to pay 0.85 dollars, 85 cents, per hour for your “entertainment.”
According to Google, the noun risk refers to a situation involving exposure to danger and the verb risk means exposing someone or something valued to danger, harm or loss. In the gambling examples above, a small amount of money is put at risk. The risk of losing is small or zero and the value of the “property” at risk is only one dollar. To most of us it is “no big deal.” But the last time I checked one dollar would buy you four packages of Ramen noodles at the grocery store. Depending on your outlook, one dollar can be worth a lot or a little. It depends on your perception of value. Repeating, risk means exposing someone or something to danger, harm or loss. How do you determine the odds and do you have a choice?
Coin flipping and craps are not the only risks one takes or can take, but calculating the odds is straightforward. But let’s change the gamble. You have $10,000.00 to invest in the stock market. How do you choose what stock to gamble on? You consult all sorts of charts reflecting popular trends and the “need” for the product of the proposed investment. If the company is sealing wax manufacturer, it is easy. No demand and the probability of making a profit is very close or equal to zero. If the company makes a new food product proven to be desirable, the probability of success, based on opinion polling, is very high. What is the expected value and what is the “correctness” of the polling data?
It is 6 a.m. and the alarm goes off. Time to get up and do what you do to get to work by eight a.m. What is the probability of arriving at work on time and not being in an automobile accident? How do you assess the risk? What is the value of the loss if you are involved in an accident? What is the expected value of getting to work on time? Can you calculate it? And what is the reward you can expect for doing your job? Clearly, the reward is part of the expected value calculation, yet the reward may or may not be monetary. What reward can justify the risk?
Till next time….