Exposure Offers Clarity in the Risky World of Investing
Last week, a conversation with a friend reminded me how easily we can confuse actual risk with our own exposure to that risk. My friend travels a lot for work, and I asked him where he planned to go this year. His answer surprised me. “I don’t know,” he replied. “With everything going on in the world, I’m not sure I want to travel as much.”
Based on the headlines, it’s tempting to think the world is falling apart. Who wouldn’t think it’s safer to just stay home, go to work and deal with our everyday lives? But there’s a problem with this supposed logic, and I’m guilty of it, too.
I traveled to Australia twice last year. One of those times, I happened to eat in the chocolate cafe at the center of last month’s hostage crisis. When I heard the news, I started playing the “what if” game. Something similar happened when I heard about the attacks in Paris. I’d been in Paris last year, too … what if?
The issue both is that we assume a one-for-one possibility. For instance, we begin to think that because a handful of commercial airplanes crashed around the world last year, air travel is suddenly riskier. But it’s not really.According to Flightglobal’s Annual Review for 2014, flying was still considered safe with “a global fatal accident rate of one per 2.38 million flights.” The review also noted that, “on this limited basis, 2014 was, narrowly, the safest year ever; the exact opposite to the claims by some media agencies that it would be ‘the worst year ever’ for air safety. The previous ‘best year’ was 2012, with a fatal accident rate of one per 2.37 million flights.”
By comparison, many people don’t think twice about getting into cars, even though the risk of becoming a traffic fatality is much greater at 10.8 deaths per 100,000 people. Many of us ride in a car every day. As a result, our exposure to dying in a car accident is actually greater than our exposure to a plane crash if we fly only a handful of times during the year. But the headlines do a fantastic job of confusing the issue, so much so that it trickles into other areas of our lives, too.
For example, I’ve already lost track this year of the number of people who’ve asked me if events in Russia, the rest of Europe or China should impact their investing strategy. Should they get out of stocks completely? Should they sell just their international investments? Should they horde butter and guns?
Let’s be really clear about this. Living, let alone investing, is not a risk-free proposition. Simply existing means dealing with risk. After all, risk is what’s left over after we’ve thought of everything else. We know what risk looks like when it shows up, but it’s very difficult to define beforehand.
In investing, we have some measures that are helpful as reference points, like volatility. But they still leave a lot of room for improvement. Risk is in the category of things we have little or no control over, making risk something that’s rarely worth our time and attention.
Exposure, however, is much easier to define and offers clarity in a risky world. If a hypothetical event were indeed to happen, we could still come pretty close to knowing how it would impact us before the fact. It’s much easier to define, measure and control because it’s about us. It’s specific to our situation and helps us know what we can do.
As we deal with a world that feels more risky, I suggest making exposure our priority. While risk poses the question, “What could happen?” exposure asks, “What impact would it have on me?” We can’t always answer the first question, which creates stress and confusion. But we always have a pretty good idea how to answer the second.
It means we talk about asset allocation in our portfolios instead of whether Russia will invade one of its neighbors. It means we weigh life insurance options instead of worrying about whether we’ll catch Ebola. And it means we wear our seatbelts in the car, even on short trips to the store.
Risk will remain hard to define and measure, even as it continues to generate some of the biggest headlines. It’s one of the unknown unknowns of the world. By understanding and evaluating our exposure, however, we can gain valuable control over our lives in a seemingly out-of-control world.
This commentary originally appeared January 20 on NYTimes.com
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