On Risk and Reward

Risk-taking is a fundamental imperative to the forward movement of civilization. Explorers and scientists that have engaged and continue to engage in risk-taking have brought us untold progress. To them we owe an endless list of new frontiers, comfort, medicine, transportation, and communication breakthroughs. The benefits from risk-taking activities in the world of commercial enterprise is equally abundant, bringing us expanded trade throughout the centuries, economic growth, jobs, etc... At the core is the uncontestable postulate that there is little that we can point to as progress that did not emanate from risk-taking. No risk-taking equals no progress.

The risk I am discussing is risk taken on a voluntary basis. Coercive risk-taking is not within the sphere of the "risk/reward=progress" equation. For example, being told to rob a bank when a gun is put to your head is certainly not voluntary nor intended to result in any benefit other than not losing your life. Likewise, running through a blazing fire to save a loved one falls in the coercive risk category as it is an action taken apart from a voluntary design.

There are two essentials needed to make risk-taking possible:

1. The ability to quantify, or assess, the level of risk being contemplated. Absent this calculation, one is unable to weigh the possible cost of failure. This uncertainty evaporates the desire to take risk.
2. Reaping a reward that is commensurate with the measured risk. The larger the risk, the more reward will be demanded.

In the realm of risk quantification, we can thank the advancements in mathematics ranging from Cardano the Renaissance Gambler (eminent 16th century physician and unmitigated gambler) to Harry Markowitz (portfolio selection theorist) and everything in-between and beyond. Without reliable risk measurements we would not have insurance companies, finance companies, medicinal innovations and a host of other disciplines that are forced to project possible outcomes in order to arrive at present-day decisions. The future needs to be somehow measurable, with known prognostication limitations taken into account.

To voluntarily agree to take a risk, you will expect a reward. Even Evel Knievel knew that. Do you think this daredevil took numerous death defying risks just for kicks? If there is no reward, then why take the risk? Most rewards are measured in monetary terms and the timing of the recompense can be expected now or in the future. However, monetary is not the only acceptable reward measure as patriotic, religious, social and family benefits are certainly legitimate reasons to accept risk.

A rational person will weigh risk and reward and determine whether the risk "is worth it". True, the spectrum of personality types can range from extremely risk-averse people to bonafide risk-lovers whose adrenaline-stimulant is risk. Everyone must decide, within their own personality make-up, whether or not a proposed action or venture is worth the risk. 

Let's look at investment risk. Should you buy a particular asset or not? There is risk that the investment's value may drop and you suffer a loss and there is the possibility that the value will rise and you will profit. When a government changes tax policy it serves to disrupt the risk-reward balance that we calculate. Let's assume an increase in capital gains taxes. If you invested wisely your reward is now less by the degree of the tax increase. However, the risk is unchanged. Clearly, this would cause many along the risk spectrum to decide that, at a lesser reward, the risk is not worth it. Progress is the victim. The more government intervenes in the risk-reward equation, the less pure the proposition becomes.

There is another way that government can be an undesired risk-reward party crasher. It can leave reward relatively untouched but, instead, lessen risk. This is also known as a bail-out. In the long run shielding risk is extremely dangerous because the risk has not disappeared. It has merely been "spread around" to the taxpayers who did not volunteer to take it in the first place and now, in an act or coercion, assume risk without hope for reward. To use a technical term -- it's a bummer. Furthermore, the reward side of this same equation will eventually get hammered down because a risk safety net is an unsustainable position to take in a free society. 

The freedom to decide to accept risk and enjoy the concomitant reward or punishment with minimal outside intervention is key to economic growth. Otherwise, we have a mess.