Back when I began contributing and investing in my 401(k), I knew there was a level of risk unlike the certainty of a bank account, but I truly had no conception of what the eventual reward would be. To me, it was unknown.
When we consider risk, it is usually the known aspect that we focus on, what we know could go wrong because it is within our realm of experience. The risk that’s not considered are the events we don’t see or can’t even conceptualize.
Risk, however, is tied to reward. The greater the risk, the greater the reward. For some risks, the reward is known and immediately recognized (betting, gambling, day trading, extreme sports, going viral on social media). These are short-term, high-stakes risks paired with short-term, high-stakes rewards. For lifetime rewards, you need to make life-altering decisions when the true reward may not be known or recognized for years or even decades later.
Investing for the long-term is known risk paired with unknown reward. It takes discipline, patience and judgment of your own doing because investing doesn’t have the collaborative nature of work or team sports/activities to compare notes and plays. It is often a solo expedition trekking along in known risk with an unestablished, unknown reward.
It is not until you actually calculate your long-term growth potential or elicit some help from a financial advisor/planner, that you begin to realize the reward of long-term investing. Most people don’t do that, especially early on, operating within their known realm of risk with no true reward in sight. It’s where the second-guessing comes in and if investing is even worth it. Where the comfort of familiarity and immediate gratification become the reward when the known risk becomes too great.
It takes courage, however, to step out of the familiar. It is where the uncomfortable trade-off begins of enduring greater risk for an unknown reward which often determines the trajectory of our lives. If we are too scared to take any risks (different job, career, moving, different investments) we can’t learn to discern between smart risks and reckless ones.
Studies show that courage is directly linked to higher levels of psychological capital (PsyCap). This is a combination of confidence, optimism, hope and resilience, exactly what is needed to stay invested for the long haul through whatever perils of risk we were completely oblivious to.
Being courageous doesn’t mean acting without fear; it means assessing both the potential reward and cost of failure in order to make informed decisions about which fears are worth overcoming and then doing it. This could be moving money to a new investment, staying invested or the start of the draw down of your investments.
For those of us who are older, we remember the times when we were blissfully ignorant of what was going on around us in the world without the constant barrage of notifications and alerts. In some ways, it was easier to stay invested back then even without the tools we have now.
The younger generations claim not to be more risk-averse but more risk-aware. Risk-aware means actively identifying, assessing and managing risks to make informed decisions that allow for calculated, beneficial risks, whereas risk-averse describes a general, often emotional, preference to avoid or minimize uncertainty, regardless of potential higher returns.
I didn’t think there was such a thing as “reward aware” until I looked it up as I don’t know anyone who is reward averse. It’s a new concept relative to AI referring to systems that understand, utilize or optimize for explicit reward signals to guide behavior and align with human preferences.
Regardless of AI eventually assisting us in knowing and understanding the rewards we have yet to experience, being risk-aware is important but having the courage to act on that knowledge even when the information is limited is far more important. It builds our psychological and investment capital.
Known risks and unknown rewards isn’t a popular topic with vast resources. There is future reading coming out later this year that is relevant. Risk and Reward: How to handle market volatility and build long-term wealth
Other sources:
How The Risks We Take Shape Our Lives (And Why You’re Taking Too Few)