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6 risk management mistakes

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in Leaders & Managers,Management Training

Here are six ways to guard against “black swan events,” those rare but catastrophic disasters that can take everything down with them.

1. We think we can predict extreme events. Most times, we can’t. Better to focus on the consequences—how it would affect your company.

2. We are convinced that studying the past will help us manage risk. Black swan events don’t have precedents.

3. We don’t listen to advice about what not to do. The harmful effects of smoking are roughly equivalent to the combined benefits of every medical intervention developed since World War II.

Does that stop smokers? No.

In terms of financial risk, a dollar not lost is the same as a dollar earned. Put the same emphasis on avoiding losses as you do on earning profits.

4. We assume that risk can be measured by standard deviation. This calculation doesn’t apply in real life, where market movements can exceed 10, 20 or sometimes even 30 standard deviations.

5. We don’t understand that what’s mathematically equivalent isn’t psychologically so.
Two formulations that appear equal by the numbers can be unequal in the way they appear to us. For instance, if you tell investors that, on average, they’ll lose all their money only every 30 years, they’re more likely to invest than if you say they have a 3.3% chance of losing a certain amount each year.

6. We’re taught that redundancy is inefficient, but cutting resources too close leaves you vulnerable to disruptions. A certain amount of redundancy—in inventories, cross-training, idle capacities and money stashed away—is protective.

Witness Mother Nature, the best risk manager of all. She loves redundancy, giving us lots of spare parts—including two lungs and two kidneys, not to mention many redundant areas of the brain—so we can survive.

And a footnote: Hubris is the greatest risk of all.

— Adapted from “The Six Mistakes Executives Make in Risk Management,” Nassim Taleb, Daniel Goldstein and Mark Spitznagel, Harvard Business Review.

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