From childhood to entrepreneurship, uncertainty is how people learn, innovate and create wealth. Harry Margulies argues that societies become less resilient when they treat every risk as a danger to be eliminated

Every worthwhile achievement, every result we enjoy today, began with someone taking a risk. The entrepreneur risks bankruptcy, the scientist risks failure, the immigrant leaves behind everything familiar in pursuit of a better life, the investor risks losing money. Even falling in love is an exercise in accepting uncertainty.

Without risk, there is no progress. But what exactly is risk?

The Oxford Advanced Learner’s Dictionary defines risk as “the possibility of something bad happening at some time in the future; a situation that could be dangerous or have a bad result.” That reflects how most people understand the word.

In finance, however, risk is often used more broadly to describe uncertainty around outcomes. The outcome may be favourable or unfavourable – no one knows in advance. Every investment, every business venture and every important life decision involves uncertainty.

The problem is that modern societies increasingly confuse risk with danger. A hazard is a potential source of harm. Risk, in safety terms, concerns how likely that harm is and how serious it might be. In finance and business, there may be no physical hazard at all: starting a company can be highly risky without being physically dangerous.

So crossing a busy motorway is dangerous but starting a business is risky. Climbing Mount Everest is both. Investing in a promising young company involves little physical danger but enormous uncertainty.

When we begin treating every uncertainty as though it were a danger that governments must eliminate, we become less resilient, less innovative and, ultimately, less prosperous.

A cartoon by the Swedish cartoonist Albert Engström featuring his character Kolingen captures the appeal of risk neatly. Kolingen is sitting in a bar with a friend. Together, they have just enough money to buy a single shot of aquavit but neither trusts the other to drink only half. A stranger enters. Kolingen slides the drink across the counter and the stranger drinks it in one gulp, immediately ordering three fresh shots for everyone. Kolingen beams with satisfaction: “I handled that well.” His friend replies: “Yes – but it was one hell of a risk.”

That is risk in its purest form. We willingly accept uncertainty because we believe the potential reward outweighs the possible loss. Sometimes we succeed and sometimes we fail, but refusing every risk guarantees that nothing changes.

Children learn this early. They need opportunities to encounter challenge and manageable risk: to climb trees, ride bicycles, settle playground disputes and experience disappointment. We learn balance by falling off bicycles, judgement by making mistakes and resilience by discovering that setbacks are rarely fatal. Childhood is nature’s training ground for uncertainty.

The same principle applies to economies. It has become fashionable to criticise corporate profits, capital gains, billionaires and, more recently, the world’s first trillionaire. Economic theory has long recognised that part of an entrepreneur’s profit can reflect the uncertainty borne in creating something without any guarantee of success. Entrepreneurs devote years of effort to ventures that may fail, while investors commit capital they may never recover. Hindsight leaves us with the successes while making it easy to forget the failures that preceded them.

Governments may also shift today’s costs onto tomorrow’s taxpayers when they rescue failing institutions, guarantee mortgages, subsidise industries or cushion economic downturns. Some intervention is both necessary and desirable. But when society expects losses to be socialised while condemning private success, the incentive to take entrepreneurial risks may diminish. We cannot eliminate risk. Instead, we should recognise and reward those willing to bear it.

One of humanity’s great economic breakthroughs was learning how to share risk. Peter L. Bernstein’s Against the Gods: The Remarkable Story of Risk traces the development of our ideas about risk, while the history of Lloyd’s shows how Edward Lloyd’s London coffee house became a centre of marine intelligence and insurance in the late 17th century. Merchants and underwriters could spread the financial consequences of dangerous voyages rather than leaving one individual exposed to ruin.

Once risks could be assessed, priced and shared, investors no longer had to face every possible loss alone. Civilisation didn’t advanced because risk disappeared but, rather, because people learned how to manage it.

The same logic is central to Henry Fiorillo’s Fool’s Gold, a book about angel investing. 

Suppose an investor puts US$25,000 into each of 10 start-ups. If nine fail completely, the lone success must return more than US$225,000 merely to break even. Even a tenfold return on that one investment would therefore only bring the portfolio back to its starting point. Success depends on understanding risk, diversifying it and accepting that a handful of exceptional successes may have to compensate for many disappointments.

Understanding risk also teaches humility. Concentrating an entire life’s savings in a single speculative investment is closer to gambling than investing. A wiser strategy protects most capital while exposing only a smaller portion to higher-risk opportunities. The mathematics of loss is unforgiving: lose 10 per cent and a gain of about 11 per cent restores your position. Lose half your wealth and you must double what remains merely to break even.

Success should therefore be greeted with humility. If your first investment doubles, do not assume you are a financial genius. If your portfolio rises during a booming market, do not mistake favourable conditions for exceptional skill. Luck almost always plays a larger role than we like to admit.

Good judgement lies in understanding which risks are worth taking and which dangers should be avoided. Innovation, successful companies and scientific breakthroughs all depend on people accepting uncertainty that others may prefer to avoid.

We cannot eliminate risk without also eliminating opportunity. The choice is between managed risk and stagnation. In other words, risk is, and always will be, the necessary price of progress.

READ MORE: ‘Andy Burnham must learn Mark Carney’s hardest lesson‘. Britain’s new prime minister has promised a political and economic ‘circuit breaker’. Canada shows why he must be prepared to abandon cherished policies when they collide with reality, writes Harry Margulies

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