I was speaking to friend-of-the-blog Michael the other day and he said,
“Jesse, your career change…it’s a huge risk, right?”
Pow! What a question. I wanted to give Michael a smart answer. I paused for a second and thought – “What is risk?”
I bet you have a gut feeling for risk – you know it when you see it. On its face, any big decision must be risky, right? After 5 years of engineering school and 7 years in the engineering industry, switching careers is risky.
Risk is an important investing topic, too. And we deal with plenty of risks in our everyday lives.
But how do I define risk? How does that definition apply to Michael’s question? Is my career change a huge risk? Is it risky at all?
So let’s discuss risk, its various definitions, and what you can do to live with risk in your life.
Let’s Start With Warren
I’ve recently been listening to Berkshire Hathaway shareholders’ meetings while I exercise. Why have pump-up music when you can learn from Warren and Charlie? (Not a joke.)
I love the question and answer that Warren gave in the 1994 meeting video below. (If the link doesn’t work as I expect it to, the question starts at 1:43:40).
If you don’t have ~5 minutes to listen, there are three important highlights from Warren:
- Risk is probability of permanent harm or injury.
- Risk is “inextricably wound up in your time horizon.“
- Risk is not the same as volatility.
Let’s apply all three of these points to answer Michael’s question about my career. Then we’ll explore risk in investing.
Is My Career Change Risky?
Could I permanently harm or injure myself (or my career) with this change?
I don’t think so.
As I see it, the worst case is:
- After two years, I scurry back to engineering with my tail between my legs.
- And let’s be honest – I probably get a ~30% pay bump over my prior engineering salary, because that’s how hot the job market is. Leaving and returning to the same company is a tried-and-true income boosting strategy.
That’s the worst case. It’s not that bad. And, in my opinion, its probability of occurring is low!
The best case is…
- I love my new job.
- I’m pursuing my passion.
- I earn significantly more in my new career than my old one.
I think the probabilities of these three occurring are high!
Risk is “inextricably wound up in your time horizon.“ What’s my time horizon?
While there are short-term repercussions to my career change, I give them a small weighting. Instead, I’m thinking long-term.
I’m hedging my short-term risk by ensuring that all my finances are in order and that my new career can more-than-sustain me in the short run. I’m safe.
On the flip side—was there a risk to staying at my old job for the next 20 years? Absolutely.
The risk is that I permanently wound my quality of life by not fully enjoying 50% of my waking hours. I was comfortable…but a little numb. That’s a risk.
And in my opinion, this career move decreases my long-term risk.
Risk is not volatility.
Has my career change caused a short-term shakeup in my life? Absolutely. That’s volatility. But it’s not risk.
- I had to buy a new wardrobe 🙂
- My day-to-day skillsets and tasks are completely different
- My commute increased from 5 minutes to 20 minutes, and plenty more tiny things
And I think my new career will be more volatile in and of itself. An engineer’s work life is fairly stable, flat, and predictable. My new life will have more successes, more failures, and more randomness.
My new career will be more volatile. But that’s not risk!
It’s Not Risky
My career change has downsides—both real and potential. No doubt about it. There are risks, but I think they’re small.
And more importantly, I think the magnitude of the upside and the probability of the upside far outweigh the downside risks.
The scales are tipped in my favor. Just like Warren Buffett’s coin flip from the video, where he has 7:5 odds in his favor.
It’s a wager you’d take every time.
Risk in Your Investing
We can apply the same definitions of risk to your investing. It’s extremely helpful.
Risk is the probability of permanent harm or injury.
Each asset class (stocks, bonds, real estate, etc.) has its own probability of permanent harm or injury.
Buying a single stock? Risky. 40% of individual stocks see a 70% decline from which they never recover (via JP Morgan). That’s permanent harm.
An index fund of stocks? Near-zero risk. Sure, index funds rise and fall with the market. The market suffers corrections and crashes. But the market tends to recover. At least, it always has in the past. The “hard” is unlikely to be permanent.
More reading: Markets Don’t Always Recover
Bitcoin? Risky. There’s a non-zero chance that cryptocurrency is an incredible Ponzi scheme that permanently goes to zero. Parts of cryptocurrency appear “real,” while other parts are obviously fraudulent, murky, or manipulated. For that reason, be very careful! Avoid exposing a large part of your portfolio to this kind of risk.
Risk is “inextricably wound up in your time horizon.“
What time horizon do you have for your investments?
In general (but not always), long trumps short. If you maintain a long time horizon, your investment assets become less risky.
Warren Buffett’s favorite holding period is “forever.” As long as he identifies a strong company at a fair price, he sees little risk over that time horizon.
Another example: check out the figure below. Would you rather hold the S&P 500 for a month or for 30 years?
Risk is not volatility.
Stock A has grown between 10% and 20% per year for the past 10 years.
Stock B has shrunk by 2% to 3% per year for the past 10 years.
Which stock is riskier? If we used volatility as a measure of risk, the answer would be Stock A is riskier – it’s more volatile. Its range of outcomes is significantly wider than Stock B.
But which stock would you rather own? Which is better? Which is worse?
Stock A is better. Obviously. Stock B is riskier —it’s consistently shrinking!
While volatility can signal the probability of permanent loss (which is risk), volatility cannot be called the equivalent of risk.
The opposite statement is true, too. Consistency (as opposed to volatility) is not the same as lack of risk. A consistently shrinking company is going to zero! That’s permanent loss. That’s a risk.
But I think there’s one exception…
Volatility can push us to do dumb things. Such as, “My tech stocks are all down 20% this year…I’m gonna sell before they go lower.” That’s a short-sighted response that will lock in permanent losses. Volatility isn’t the risk, but it can influence risky behavior.
Your investments will be volatile. That’s almost a guarantee. Make sure to run a fire drill for your investments.
At Risk of Droning On…
Risk is more than asking “what’s the downside?” It’s about timing, opportunity costs, and the probability of going to zero.
I feel good about my career change, and I feel good about how I invest. I hope this helps you, too.
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