Key Messages
Understanding Risk: Learn to Mitigate Risks by Looking at Examples from High-Stakes Professions
When we make decisions, it is important to take into consideration the potential risks and rewards associated with each choice.
Too often, we fail to consider these things, ending up in sticky situations because of it.
With the help of An Economist Walks into a Brothel, you can learn how to make sensible, reward-focused choices that will keep you out of trouble.
The book explores the concept of risk through curious professions such as jet skiing instructors and multi-millionaire poker players.
From this, we can identify ways in which risk can be minimized and reoriented towards more rewarding outcomes.
It also follows Hollywood studio executives as they manage perceived financial risks when investing in movies — giving us insight from high-stakes decision makers on how to diversify opportunities and spread out our risk for maximum success.
Ultimately, this book arms us with the strategies we need to make better, more rewarding decisions in our everyday lives.
Whether it’s choosing what restaurant to eat at or which job offer to accept — understanding risk and its potential fallout can help guide you towards smarter choices with greater long-term rewards.
The Key to Successfully Taking Risks Is Defining a Clear Goal
If you want to make a bold, risky choice, the primary message you should take away is that every risk should be taken in service of a clearly defined goal.
Before even considering the notion of taking such risk, you should think about the ultimate goal that you want to achieve and make sure it is specific.
Without this, it’s impossible to determine whether or not the risk is worth taking.
After defining your goal, you should also consider ways to reach it with minimal or no risk.
With some goals that won’t be possible but if there are low-risk options available, they should be considered first, as they will rarely require more money or time than higher-risk ones do.
The only time when a high-risk option may be best suited for achieving your goal would involve situations when taking any other route will be impossible or undesirable.
An extreme example of this situation would involve sex workers who choose to work in Nevada’s legal brothels over other occupations since their earning potential is potentially huge and their safety and physical health are somewhat protected by regulations.
Despite the protection offered by these regulations however, these women still face a lot of uncertainties including reputational risks and arrest.
In cases like this where taking an alternative route won’t technically feasible or desirable either, then it may be best to take on the risks head on if doing so helps you reach your ultimate goal
Don’t Depend on Past Results to Measure Risk – Consider All Possible Outcomes and Stay Up-to-Date with Data
In our daily lives, it’s easy to make decisions based on what has worked in the past.
Generally speaking, if you need to be at work by 08:00 a.m., and your morning commute usually takes half an hour, you leave your house at 07:30 a.m.
You do this reasoning that it will take you the same amount of time each morning, so you don’t have to worry about being late.
However, this assumption doesn’t always work out in reality.
Unforeseen circumstances like traffic or bad weather can cause delays and mess up your calculations.
This is why past results are a poor way of predicting risk for future events- too many variables come into play that you won’t be able to anticipate with such a simple analysis of data from the past.
The principle holds true for larger scale decisions too- whether it be financial investments or movie releases.
For example, movies can be expensive investments costing millions of dollars yet there isn’t enough data on their success rates leading up to their release so as to know exactly how successful they’ll be when released without fail.
Even if there were historical stats showing how many flops versus successes had been made in the past from similar investments, they would not provide an accurate reflection of real life outcomes due to changing market trends over time and other unpredictable elements associated with movie making decisions.
And even if a certain data set appears complete, assumptions should never be made that inaccuracies or errors cannot alter or invalidate its conclusion.
Risks can change on a moment’s notice and must be approached with caution and due diligence regardless of any predictions based on historical records- otherwise we may miss out on opportunities or suffer costly losses if we rely solely on these broad generalities instead of taking proactive action within our own sphere of influence in order to maximize success results both now and in the future.
We Routinely Overestimate Certainty and Underestimate Risk by Prioritizing Utility Over Value
It is an oft repeated and accepted adage that people perceive risk not in a wholly rational manner.
The economist’s notion of risk-aversion is rooted in the instinctive dislike of incurring loss but humans are prone to attaching emotional values to potential outcomes and this bias can lead to irrational decision-making.
Take, for example, a hypothetical situation where you participate in a high stakes poker tournament and the grand prize is a handsome sum of money – ten million dollars!
Such as stakes leaves with two options – take a chance on all or nothing or split the money with your opponent.
Most would choose the guaranteed payoff because, who wouldn’t? However if our opponents are already millionaires, they stand to gain little from the money won and this experience may be worth more for them than its actual value.
They may then opt for taking their chances in pursuit of utility over actual value which fails to account for how fixed the odds can be.
In similar fashion, lottery players too seek only after rewards and hardly ever consider the likelihood of winning .
Despite understanding that such odds are heavily stacked against them they still make wagers based purely on emotion.
As such, it becomes easy to tap into these impulses by creating appealing slogans like “you can’t win if you don’t play”.
This tactic understates potential risks while overlooking facts necessary to make informed decisions.
Lastly, even when studies show tiny increases in chances of suffering ill effects due to certain products or drugs caveat emptor remains largely ignored as people latch onto emotive terms like ‘double symptoms’ without truly grasping its numerical implications.
The Key to Reducing Unnecessary Risk is Diversification
When it comes to managing risk, diversification is an important factor.
Systematic risk affects the entire structure rather than just the individual, while idiosyncratic risk is unique to a specific field or asset.
To protect against this kind of risk, having a diverse portfolio can be beneficial.
Diversification helps protect against unnecessary risks by spreading out investments across different stocks or assets.
It’s often done in finance to reduce idiosyncratic risk when investing in different companies.
Studios also use it by developing a whole slate of movies instead of relying on one or two at a time and obtaining earnings from multiple means like home video formats and streaming services.
Even horse breeders employ diversification tactics by attempting to recreate champion racehorse characteristics through breeding with many mares.
Moreover, science and technology are making diversification more efficient throughout different industries.
Financial analysts can create diversified portfolios that reduce potential risks while veterinary science can match horses with mares that increase the odds of successful offspring.
Computers are being used to aid in data collection which enables studios to deliver movies digitally for audiences efficiently as well.
Risk Management: Hedging and Insurance Help to Reduce Potential Losses While Holding onto Potential Rewards
Hedging and insurance are two of the most effective ways to reduce the risk of potential losses.
Through hedging, we put some of our money into less risky investments like bonds, which will not yield as much as stocks, but provide protection in case the stock market takes a dive.
Businesses use it as well – airlines often fix fuel prices to make sure they won’t suffer if oil prices rise.
Insurance is a tool to cover against potential risks while still having a chance at reward.
For instance, car insurance allows us to drive knowing that if an accident happens, damages won’t have too profound of an effect on us financially.
In the financial industry, stock options are a form of insurance against a sharp fall in price.
Critics point out that this sense of safety may persuade people to take unnecessary risks, for example with Jet Skis being used during surfing activities.
However many consider it to be beneficial because it offers protection and encourages surfers to push their limits further and contribute positively towards the growth of the sport.
It is Important to Protect Yourself from Uncertainty as Well as Risk in Order to Succeed at Risk Management
Whether we’re talking about the deployments of a military unit or our personal finances and investments, it is incredibly important to protect ourselves against risk and uncertainty.
In order to do this effectively, we must take into consideration all of the potential outcomes (even those that may be difficult to predict).
Risk models can backfire if they don’t account for unpredictable outcomes.
For example, in an intense and volatile situation it can be easy to become overwhelmed by emotions and break away from planned strategies.
The most effective way to avoid this problem is to stay mindful of what is happening in the present moment – always be ready to switch tactics or stay on course as necessary.
It’s also important not to rely too heavily on technology.
Sophisticated cyber criminals can easily use the same tools we employ for convenience against us.
It is up to us then, to keep ourselves educated and prepared, so that these powerful technological aids are always working for us rather than against us.
Wrap Up
The book “An Economist Walks into a Brothel” is an informative journey that teaches readers the fundamental principles of risk management.
The author, Anthony Shorris, expertly explains six key elements that can be applied to help manage any type of risk: good planning, current data, diversification, hedging, insurance and flexibility.
These concepts are beneficial when applied to financial matters as they can equip readers with the knowhow to reduce their risks in these areas and are also relevant in personal situations like relationship choices — understanding your fears and seizing on opportunities can lead to enhanced growth.
Ultimately, this book is about recognizing potential risks in all aspects of life and using them as tools for success.
