The Three Sides of Risk

• The odds you will get hit.
• The average consequences of getting hit.
• The tail-end consequences of getting hit.

The first two are easy to grasp. It’s the third that’s hardest to learn, and can often only be learned through experience.

We knew we were taking risks when we skied. We knew that going out of bounds was wrong, and that we might get caught. But at 17 years old we figured the consequences of “risk” meant our coaches might yell at us. Maybe we’d get our season pass revoked for the year.

Never, not once, did we think we’d pay the ultimate price.

But once you go through something like that, you realize that the tail-end consequences – the low-probability, high-impact events – are all that matter.

In investing, the average consequences of risk make up most of the daily news headlines. But the tail-end consequences of risk – like pandemics, and depressions – are what make the pages of history books. They’re all that matter. They’re all you should focus on. We spent the last decade debating whether economic risk meant the Federal Reserve set interest rates at 0.25% or 0.5%. Then 36 million people lost their jobs in two months because of a virus. It’s absurd.

Tail-end events are all that matter.

Once you experience it, you’ll never think otherwise.

– Morgan Housel