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  • Julian Talbot

Luck, the Sibling of Risk

"The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side." – Morgan Housel

If risk is part of a family of ideas, we might well describe it as the offspring of the marriage of objectives with uncertainty. In which case, its siblings would be randomness and luck.

Managing the effects of randomness can be understood as consequence management and preparing for the worst (or best). But luck might be another thing entirely. As Samuel Goldwyn observed, "The harder I work, the luckier I get." Hard work making us luckier is something that most of us can relate to, but it doesn't tell us what luck is.

One view is that luck is the success or failure brought by chance rather than through one's actions. Unfortunately, risk management is silent on the topic of luck. That may be because we believe we can't manage or measure it. But we retain a significant blind spot if we ignore the role of luck.

If we manage risk, luck is the only remaining variable.

In some circumstances, luck may be the most significant influence on outcomes. As the IRA commented to Margaret Thatcher after a failed assassination attempt, "We only need to be lucky once. You need to be lucky every time."

The premise of the Spanish film ‘Intacto’ is that luck is a commodity that can be given and received, won, or lost, stolen or traded away. Most people have ordinary luck; some have unusually good or bad luck. One character, Tomas, is the only survivor of an airplane crash, beating the odds (according to the movie) of 237 million to 1.

Another character, Sam, survived the Holocaust and now operates a remote casino at which rich people bet against his luck, usually unsuccessfully. So unshakable is his confidence that he will remove one bullet from a chamber holding six and then bet he will not die. That he is alive to be a character in the movie speaks for itself.

Many people blame bad luck for their failures, but few people want to believe that their successes are due to good fortune or external factors. Daniel Kahneman once wrote that when planning, we focus on what we want to do and can do, neglecting the plans and skills of others whose decisions might affect our outcomes. When explaining past outcomes or predicting the future, we focus on the causal role of skill and neglect the role of luck. We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.

When I ask risk managers or business owners how much their success depends on their efforts, the answer is never less than 80%. Even when they are not sure they will succeed, these confident individuals think their fate is almost entirely in their own hands. They are almost certainly wrong. The success of our initiatives depends at least as much on the economic environment or the actions of our competitors and adversaries as any other factor.

In a closed real-world system such as a casino (not the fictional casino in Intacto), we can quantify the role of luck. If someone walks into a casino with $10,000, we know how much of that $10,000 will likely remain with the casino operators depending on the games they play. If our fictional gambler leaves with more or less money than probability predicts, we can theoretically assign that difference to luck.

The real world, however, is an open system with infinite complexities and possibilities. We may perhaps understand and measure luck in the future, but there is more to fortune than just managing or measuring it. The Roman philosopher Seneca for example offers the insight that "Luck is what happens when preparation meets opportunity."

This concept aligns well with risk management principles and ideas. But in truth, our understanding of luck is so poor that we cannot even tell good luck from bad luck. A Chinese proverb perfectly sums up the situation.

A farmer and his son had a beloved stallion who helped the family earn a living. One day, the horse ran away, and their neighbors exclaimed, "Your horse ran away. What terrible luck!" The farmer replied, "Maybe so, maybe not. We'll see."

A few days later, the horse returned home, leading a few wild mares back to the farm. The neighbors shouted, "Your horse has returned and brought several horses home with him. What great luck!" The farmer replied, "Maybe so, maybe not. We'll see."

Later that week, the farmer's son was training one of the mares when he was thrown to the ground, breaking his leg. The villagers cried, "What terrible luck!" The farmer replied, "Maybe so, maybe not. We'll see."

A few weeks later, soldiers from the army marched through town, conscripting all the young males for the military. They did not take the farmer's son, who was still recovering from his broken leg. The neighbors said, "Your boy is spared; what tremendous luck!" To which the farmer replied, "Maybe so, maybe not. We'll see."

Any single event may bring positive or negative outcomes. But that doesn't make it automatically good or bad; only time can tell the whole story. In his novel, No Country for Old Men, Cormac McCarthy observed, “You never know what worse luck your bad luck has saved you from.”

On September 20, 1999, several shots shattered the windows of the Australian Embassy in Indonesia. The Embassy had been the target of daily protests since Canberra led a multinational force to counter the Indonesian invasion of East Timor. Fortunately, nobody was injured, but the Australian Government spent millions of dollars to bulletproof the windows after this incident.

Five years later, on September 9, 2004, a one-tonne car bomb exploded outside the Embassy, killing nine people at the gate and wounding over 150. The blast damaged surrounding buildings, and broken glass injured people in buildings up to 500 meters away. Inside the Embassy, however, nobody was seriously injured thanks to the window treatments in 1999.

Although we can't tell with foresight, which events represent good or bad luck, there are some things that we can already do. For example, a tiny group of casino players can teach us about luck management, particularly the importance of room for error.

The fundamentals of blackjack card counting are simple. No one can know what card the dealer will draw next, but by tracking what cards have been dealt, a player can calculate what remains and evaluate the odds of a particular card being dealt next. Card counting is proven to work, but it does not guarantee you will win every hand. Players must ensure they have enough reserves to withstand any swings of poor luck.

This wisdom in having room for error acknowledges that uncertainty, randomness, and luck are ever-present. Benjamin Graham, known for his investing prowess and quantitative approach to risk management, was also renowned for maintaining a margin of safety. My favorite quote is one he mentioned in an interview. "The purpose of the margin of safety is to render the forecast unnecessary."

Maintaining a margin of safety in our risk management strategies might cost resources, time, or money. But it is something worth maintaining.

Relying on perfect risk management is no more adequate than relying on being lucky.

In hindsight, many things appear to be down to good or bad luck. There is much that we don't know about luck and much more that we are likely to know in the future. But we have all heard about organizations or people that were "so lucky to have bought that property all those years ago when it was cheap", "lucky to have sold half their investments just before the crash," or "fortunate that their doctor detected cancer early" and so on.

Clint Eastwood's most quoted line from Dirty Harry is, "You've got to ask yourself one question: 'Do I feel lucky?'"

So do you feel lucky? How effective is your luck management framework? If you have given it any thought, did you also preserve an appropriate margin for error?


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