When more volatile is less risky

What is “safe”?

In the investment world, a safe investment is one that doesn’t move very much. It’s not very volatile. It’s predictable.

We like predictable. They’ve done studies that show how humans (and chimpanzees) like to pick the certain choice, even when the less-certain choice has a better chance of high benefit. We can get a little more excited about random chance when we have the chance to gain money (see: Las Vegas), but when it comes to potentially losing something, we shut right down. We hate chance. We hate uncertainty. We want to be safe. We want to know what will happen.

Overall, the safe = less volatile thing is a pretty good rule of thumb. As far as saving time and mental energy while yielding reasonably accurate results, it does a good job, most of the time.

But like any rule of thumb, it’s wrong sometimes. This post is about when it’s wrong.

What if the certain route is certain failure?

In the competition for MTG Player of the Year, Guillaume Matignon faced a bad situation: the cards he had were simply not as good as the cards his opponent had. They were good, and made a strong, consistent deck, but unfortunately they made a strong deck that was consistently slower than his opponent’s.

So he had a choice. He could play that strong, consistent deck. This is the “safe” option: it has a very predictable outcome. But that outcome is that he loses.

Or he could play a less consistent deck. One that — if it works — can work spectacularly and win him the game and — if it doesn’t work — will cause him to lose the game much more quickly than he otherwise would have. This option is much more volatile: he has no idea, going into the game, whether he will win hard or fail hard, but whatever he does, it will be fast-paced and intense.

What’s the less risky option?

Traditionally, we associate volatility with risk, so we would say that the first desk is less risky.

And yet, something has clearly gone wrong when you look at a situation and say “You should do the thing that’s guaranteed to fail — it’s less risky.” I mean, we try to avoid risk so as to improve our chances of success. When we box ourselves into a nice, safe, jail, we have to have taken a wrong turning somewhere.

Let’s look at a situation we’re more familiar with: there are 5 seconds left in the game, and your team is down by 1.

If you don’t take the shot, you have a very predictable outcome: you lose. If you DO take the shot, you have a less predictable outcome: you might make it, and win or tie the game. Or you might miss, and lose. Taking the shot is more “risky”, more volatile.

But everyone agrees that you take the shot. It’s your only chance of winning for heaven’s sake!

And that’s the thing. Sometimes volatility is your only chance of winning. And in those cases, although that option is volatile, it’s also less risky.

How will this help you win?

It all goes back to the fundamental decision-making question: what will help me win?

If reducing volatility will help you win, then it’s a good thing. And that’s very often the case.

But sometimes your only chance of success is to take the outside shot, to try drawing to an inside straight. If you fail, you are in exactly the same situation as if you didn’t try for the outside shot.

So you may as well try it.

Epilogue:

Guillaume Matignon played the more volatile deck. He got lucky draws and won the game, but lost the overall playoff in other games.

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Resources for Further Reading
Dangerous? Or Gutsy?
Intelligent Risk Taking

  • K-eM

    I am known for saying, “The worst that can happen is that they say no.” Why not run the risk if the WORST that can happen is that you get the same response you’ll get going the safe route?

    • apingel

      Exactly! In many cases you literally have nothing to lose.