Notes from “The Psychology of Money” | Book Summary | Luck and Risk

In my previous post on the book Psychology of money, I talked about how understanding the concept of Compounding can give you an edge in your investment journey. (In case you did not read that post, I recommend you start with it as it also introduces the core concept of this book). In this post, I will be talking about Luck and Risk and how they play a very important role in everyone's life.

Luck & Risk

More often than not peoples' success is attributed to their hard work and their failure to some bad decisions. The issue with that is, no one talks about the role of Luck and its counterpart Risk which happen to play a major role in a person's success. Generally, there are two reasons why people don't talk much about them.

If we start attributing some other person's success to luck it makes us sound jealous. On the other hand, if we talk about our success as luck, It is kind of demoralizing. To acknowledge the fact that they exist let's make a case below is a real-life case study: Bill Gates.

Mother of Luck

Bill Gates the ex-CEO of Microsoft, is one of the richest men in the world. A brilliant man, a tech visionary and a computer genius, he is all of these things. I have often heard people say that Gates was born to be rich. But here is a lesser-known fact about him.

When Gates was 13, he attended the Lakeside School, Seattle, USA. The interesting thing about this school was that it was one of the only schools in the entire US which had a computer.

This very computer was what enabled Bill Gates and his friend Paul Allen, to study and understand computers from a very young age. This headstart is what lead to the birth of Microsoft.

So here is the thing, what are the odds of Bill Gates in 1969 was living in Seattle and was one of the 300 students to attend the only school with a computer? Should be easily around 1 in a million. That's what we call the rare of the rarest events. Bill Gates himself in an interview said

If there had been no Lakeside, there would have been no Microsoft.

There is no doubt Bill Gates is extremely talented and what you would call a tech genius. But what would have happened if he never had access to that computer? He wouldn't have the opportunity to learn about computers and Microsoft would have never been born.

That's what we call lady luck in play. But wait, there is more to Gates's story. If establish that there is luck with the example we can establish its counterpart as well. That is Risk.

The following is the story took in the same school as Bill studied i.e. Lakeside. The story of his best friend Kent Evans.

If There Is Luck There Is Also Risk

Kent Evans also went to the same school as Bill Gates. He was Gates's closest friend and was also equally good with computers.

Gates said that Evans along with Paul Allen would have been the co-founder of Microsoft if things went well. But we know that never happened. That's because Evans died in a mountaineering accident.

Mountaineering accidents don't happen often, in the US the chances of them happening is one in a million. It was unfortunate that Evans was unlucky. But you realise, Evans had the same luck Bill Gates did: Opportunity to work with a computer and an innate gift to be good with them. But he was struck with unpredictable risk.

These concepts are important to keep in mind when we are investing. There are some days when luck may be on your side and we make huge profits. But you also realise that there would be one day when a random risk may prevail, no matter how small its chances are. That's why we must always remember to respect roles of random luck and risk when we play our investment game.

How To Apply This To Your Investments?

Here are a couple of things you should keep in mind after knowing about luck and risk.

Paranoia

Always have a slight amount of fear, that what you gained can also be easily taken away. Since we never know when bad events can happen, when you invest, in case you are planning to put in a large amount of money on a particular stock, think twice and consider the random risk of the stock price going to zero.

Once you start doing that you will start thinking about backup plans and have some savings which help you lead a happy financial life.

Be Flexible

Since we don't exactly know when events of random luck and risk can happen, a simple thing we can do to lower their impact is not placing all our bets on a single investment. If we do that in case the investment hits a random risk we lose everything.

Don't place all your eggs in one basket.

Instead have a wide range of things where your investments go. Doing this will ensure that you will not be broken in case a random risk hits, you will always have some to hold you up. On the other hand, even if a few of your investments hit random luck, you may get rich as well.

Change The Way You See The World

Some things are outside peoples' control. That makes it hard to study the role luck played in someone's success.

So be careful whom you praise and whom you look down upon. Since luck and risk in peoples' life are not visible.

If you are looking at the Forbes top 100 most likely these are extreme cases of luck and you should be considering that.

And also on the bright side if you fail at something don't get demoralised. Accept that the failure may not be due to your inability that this could be an issue of random risk.

Doing these will make sure you are mentally healthy.

Hope the post was helpful, please feel free to share your personal experience with luck and risk in the comment section below.

Stay Tuned

The next important thing I learned from the book was the importance of Tail Products. I would be sharing my notes related to that in the next week's blog post so stay tuned.

• If the insights I shared sparked an interest in you about the book. You can use the following link to purchase it. I would get a tiny kickback from it.

• Here is a link to my previous post Introducing the topic of the Psychology of money with Compounding, do drop by to read it.
• There is also a webinar I took on the same topic, you can check it out if you are interested.