Kuta Beach

Kuta Beach

Saturday, 27 February 2010

Blind Optimism

A 17-year-old has gone to the Invested forum and posted his goal of being a millionaire by 20:

I'm 17 years old and I have a goal of making one million dollars before I turn 20. That gives me just under 3 years.
...at the moment I am interested in learning about the share market and trading silver and gold.
Quite a few people told him being a millionaire by 20 is extremely difficult and he would likely have to do risky things, e.g. borrow money from the bank to trade gold.

However, what surprised me was the number of people who lept to the kid's defense, saying that his ambition was admirable and that he should forget about those who warn him of the dangers and go to the goal regardless of the risks.

This is like a drug lord asking you to transport heroin from one country to another. The drug lord claims he will pay you $250,000 if you transport the drugs, but if you get caught by police you may spend decades in prison or, in some countries, be executed. The drug lord will use all the same arguments: forget about the risks, aim high, you can do it, etc.

My point is that it is important to not be blindly optimistic and ignore the risks that other people may point out to you. Suppose you have a desire to commit a crime that may profit you immensely, but the risks may put you in prison. Some people who know about your criminal plans (e.g. your parents) may try to warn you not to proceed with the crime. The idea that you must believe in yourself, ignore everyone who says you cannot do it, and just do it regardless of the risks, is very dangerous.

If a friend of yours decides to transport heroin from one country to another (i.e. be a drug mule) and you try to discourage him because of the risks, and it actually turns out that your friend is successful and scores $250,000, it doesn't mean that your trying to discourage him was somehow wrong. You notified him of the risks. It also doesn't mean that you suffer from tall poppy syndrome because your motive for notifying the friend of the risks may be because you are concerned about him. The risk-return tradeoff is a fundamental concept in finance theory. It pretty much states that in order to make a lot of money you will have to take on much more risk. Just because a person can cite a story of a successful drug mule who is a millionaire from all the drug trafficking he has done, it doesn't mean the risk-return tradeoff is disproven. If a potentially lucrative activity is risky, for all the success stories you can find you will be able to find hundreds of stories of failure. If you hear of a story of a millionaire who won the lottery and you think that buying a lottery ticket is a worthwhile path to riches, you should balance this idea with the stories of the millions of lottery ticket holders who do not win and spend their lives buying lottery ticket after lottery ticket hoping they could win.

My main point is to have a goal but to be mindful of the risks. An appropriate risk management framework is essential for most businesses, so why shouldn't an individual think about risk?

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