Understand your risk preference, and make better decisions
Decision making affects everything you do. From the moment you wake up, you’re making decisions. Everything, from what you wear to what time you leave for work, requires a decision, however small. And inherent in almost all the decisions you make is an element of risk.
To make the best decisions you can, it is important to understand how you approach the decision making process.
For each decision you make, there are unknown elements that you can’t control. Consciously or subconsciously, you evaluate these unknowns and the potential outcome of each alternative when you take a decision. However, the payoff and the risks involved are not absolute: They’re estimated, and are therefore colored by your perception. In turn, your perception is strongly influenced by your propensity to take risks.
By nature, some people are more tolerant of risk than others. We all know people who thrive on big risks. People who gamble or take part in off-piste skiing are typically pretty risk tolerant, as are those who invest in new markets and emerging technologies. To them, the excitement and potential rewards make the risk worthwhile.
Before they participate in these activities, though, they make a decision to do so. This then implies that decision making is affected by your risk profile. When you’re amenable to risk, you tend to consider and embrace riskier options. People who need more stability and control tend to choose far less risky options.
Understanding your Risk Propensity
So, in thinking about your decision making, you need first to understand your attitude to risk. Are you risk averse, a risk taker, or does it depend on the situation? The amount of risk you accept in your decisions is related to your overall risk profile. Some people are simply more cautious by nature. So what the cautious decision maker deems high risk, may have a lower risk assessment when analyzed by the “courageous” decision maker.
This is important because we all have to take risks in our life if we’re to achieve our full potential, and it makes sense to try to find the middle path between suffocating caution and reckless optimism. The ability to find this middle path, to be able to take risks intelligently, is a great advantage in many business situations.
Research has shown that your personality type is a good way of predicting your risk propensity. Click here to find out more about a good approach to personality typing, and to take a quick self-test that will help you understand yours.
People fall into three groups when it comes to risk propensity. Some people are through-and-through risk takers. Not only do they thrive on the sensation of danger, they will actively seek out this thrill. In terms of personality type, they will tend to have high Extroversion and Openness scores, and low Agreeableness, Natural Reaction/Neuroticism and Conscientiousness scores (see the personality types article to find out what this means.) These people like to have fun, enjoy the “buzz” of novelty and danger, and aren’t too worried about what others think of them.
People with the opposite personality scores (Introverts with low Openness, but high Agreeableness, Natural Reaction/Neuroticism and Conscientiousness) will normally be risk averse.
The third group contains those whose propensity to take risks depends on the situation. These people tend to have mid-range scores on most of the “Big Five” personality dimensions. Their approach to risk tends to differ across following the six main areas:
- Personal safety
- Personal finance
Examples of people whose risk propensity is different in each of these areas include a fast-driving smoker who stays within one company for his whole professional life (taking risks with personal safety and health but not with his career), or someone who gives up a well-paid job to start a new business yet always wears a cycle helmet (taking risks with her personal finance but not her personal safety).
Risk Propensity and Decision Making
Once you are fully aware of your approach to risk in decision making, you can start to think about how your natural risk appetite is influencing your decisions. If you are naturally a “courageous” decision maker, then you may want to increase the amount of analysis you conduct, so that you avoid taking unwarranted risks. On the other hand, if you are a “cautious” decision maker, then knowing that may help you to break free of constraints that may be holding you back.
Here’s how to use your understanding of your risk propensity when you have to decide between two or more options:
Step One: Analyze the Riskiness of Each Option
First of all, you need to identify the dangers inherent in each option, the likelihood of their occurring, and the potential impact they’d have if they materialized. One of the key tools available for this is risk analysis.
Once you’ve calculated the risks for each option, and considered how you could manage these, rank your options according to the riskiness of each one, and decide which is your preferred option.
Step Two: Compare Your Risk Propensity to the Riskiness of Your Preferred Alternative
If you’re naturally a “courageous” decision maker who enjoys taking risks, and you’ve chosen a high-risk option, step back. Consider whether your choice is influenced by the excitement that this risky option would bring. Although a high-risk option seems the most attractive to you, is it really the best choice, or are you just seeking an “adrenaline buzz”?
Equally, if your tendency is towards risk-averse, “cautious” decision making and you’ve chosen the least risky option, check that your natural prudence isn’t getting in the way of a truly objective assessment of the choices available.
Being aware of you own propensity to take risks is of great benefit when making decisions. Risk-taking people preferring high risk options should consider reviewing their decisions carefully. On the other hand, risk-averse people wanting to take the safe option may need to push themselves if they’re to achieve the best outcomes. Being aware of your risk patterns will help you to determine if you are truly choosing the best option, or if you’re letting your risk profile influence the decision more than it should.