Types of Risk
So, I promised some info related to my CRM Principles of Risk Management course that I recently attended. The instructors were bright, articulate and engaging and as a result, the 20 hours of instruction went by fairly quickly. As you may deduce from a “Principles” class, the essential focus was the basics of risk. The class was a fairly large one, with about 90 people. It was also a very highly credentialed group, with about 120 designations granted to these folks. Definitely no slouches here.
The first risk concept explored is an identification of the three generally accepted types of risk, each with their own unique characteristics. They are:
- Pure Risk;
- Speculative Risk; and
- Gambling.
Pure Risks are those where there’s a chance of loss *only* with no possibility of gain. An example of this might be an airplane falling out of the sky wiping out a city block or the death of a loved one. With respect to individuals, insurance does a good job of protecting against many pure risks we face in our daily lives.
Speculative Risks are those where there is a chance of a loss OR a gain. These risks include a *variation* of outcomes where profit is possible. An easy example of this is investing. We invest money in stocks, bonds, commodities, etc. with the hope of a positive result (profit), but where exists the possibility of loss. To spin this concept to financial academia, having the majority of your investments in one company or one industry group, is called “speculating” (and not investing), and we all know how dangerous that can be!
Starting and operating your own business is another form of speculative risk. For my money, this is, for most individuals, the most “risky” speculative financial risk. Since I have been a “serial entrepreneur” (stop me before I start another business again!) all my adult life, I guess this is why stock market investing seems nowhere near as risky as the commitment and deployment of capital in my own business.
The last risk group is gambling, where there is the chance of loss or gain, but the probabilities strongly favor a loss. I highly doubt this type of risk needs any explanation. Anyone who has ever been to Las Vegas or Atlantic City (or watched CSI: Las Vegas on television) understands this type of “risk”. In the real world, I’m not sure that gambling is really a form of risk. I don’t consider shooting craps or “putting it all on red” to be forms of risk, as I think it’s a virtual certainty that a loss will occur.