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Risk, crypto and a hatred of uncertainty

What is risk?

Depends on who you ask. Some people will go skydiving but not scuba diving. Others will take drugs but not speed on a motorway. (In any sense). Others may frequent William Hill but not buy shares. 

Risk in the investment world usually refers to volatility. It’s the difference between the highs and lows, more than the absolute chance of losing everything. But our love of gain is less than our fear of loss, and so we make illogical decisions. 

I’ve done a bit of work with consulting psychologist Paul Davies. Once you get over the fact that you’re talking to someone who can psychoanalyse your every flaw, he’s a good guy! I’ve been talking to him about risk and the frankly insane fascination with cryptocurrency.

 

 

Cryptomania

Last year it was the only finance story in town that the mainstream press wanted to cover. And it seemed like the same people who wouldn’t buy a few FTSE100 shares because it was too risky, were gaily sailing into Ether and Bitcoin.  

 

Why? Is there an in-built tipping point where the potential returns becomes so big that we throw our ‘logical’ risk responses away and shout “oh stuff it I’m in”. And if so (slightly playing Devil’s Advocate here) – shouldn’t investment firms be marketing emerging markets equity products only to get the popular vote? On the “You might make 50% you might lose 50% ticket"? Irresponsible, you say? But surely less so than crypto? At least you’re buying companies which make things, offer tangible goods and services and have business plans we can understand?

 

 

Parallels with Trump

Paul likens the crypto craze to a broader anti-establishment movement. “This is purely conjecture from me, but could this have parallels with Trump coming to power? Many have hypothesised that people had become so bored and tired of the stale old way that politicians ruled, that when something new came along, however absurd it was, it felt like trying something new. Hillary represented the same old thing, whereas Trump was something new. It got to the point where ‘better the devil you know’ no longer had any appeal. Could you argue that investing, with all the press (and even a Hollywood film) around the 2008 crises, people were on the same edge of needing something new and exciting – and along pops Bitcoin. The Trump vote was more a vote against the establishment than a vote for the big orange fella, and Bitcoin was a demonstration of saying we can invest in new ways.”

 

Was voting for Hillary in fact seen as the risky decision if she was seen as part of the establishment and likely to maintain the status quo. “It’s eerie that the rise in Bitcoin’s popularity was on a timeline in parallel to the financial crises, so was entering this market felt by investors as a less risky strategy than traditional investing? Was it a more emotional decision away from traditional methods which had every newspaper and news programme berating the financial system, into the hands of an unknown force?”

 

He also questions whether people correlate Bitcoin with risk. “It’s been demonstrated again and again that people make the 'investment mistake' of investing too much into the company they work for (with share plans and so on). They feel this is a less risky strategy, as they have the overconfidence of being part of the company, whereas really it’s high risk to have all your investment eggs together. In the same way, maybe people don’t equate Bitcoin with risk?”

 

 

We hate uncertainty

There’s also a subtle difference between risk and uncertainty – which one of these freaks people out about investing? “Take the London Underground, people would rather have a sign telling them the train will arrive in 6 minutes than have no sign and wait 4 minutes. In other words, people sacrifice time for certainty here. When investing, is it the element of uncertainty rather than risk which plays a role in their decision, with them preferring the certainty of savings or premium bonds (which lock-in the loss of inflation).”

 

We’re digging into all of this a bit more – as always super interested in your thoughts. Industry readers can see Paul on stage with me at our annual conference in September where we’ll be handing down the results of some more research into risk and investments.