Risk Management & Regret Minimization

The best portfolio managers are not the ones with the best ideas or the highest hit rate, but the ones who excelled in managing their risk. The key in assessing risk/reward is not the reward, but rather the risk. What is your worst case scenario? Is it a potential career ender? As the chinese saying goes, 留得青山在，不怕没柴烧。As long as you stay afloat, you can always mount a comeback. The worst mistake in the hedge fund business is not making monetary losses, but rather a regulatory censorship of any kind. Once your integrity is tainted, it's all game over.

Risk management is not just crucial in the portfolio management business, but also in other industries. Amazon's Jeff Bezos uses a structure he called the "regret minimization framework" to make major business and life decisions. As the name suggests, he seeks to minimize the number of regrets one can have. Here is a much younger looking Bezos explaining his thesis:

The framework I found, which made the decision incredibly easy, was what I called — which only a nerd would call — a “regret minimization framework.” So I wanted to project myself forward to age 80 and say, “Okay, now I’m looking back on my life. I want to have minimized the number of regrets I have.” I knew that when I was 80 I was not going to regret having tried this. I was not going to regret trying to participate in this thing called the Internet that I thought was going to be a really big deal. I knew that if I failed I wouldn’t regret that, but I knew the one thing I might regret is not ever having tried. I knew that that would haunt me every day, and so, when I thought about it that way it was an incredibly easy decision.

It is truly better to have tried and failed than not try at all. How likely is one at their deathbed looking back at his or her life and laments the number of things that they wish they had the guts to do when they were younger? Perhaps if we know the most common regrets those dying have, then maybe we can take precautions early in our lives to minimize the regrets that we will have when we are 80.

Bronnie Ware was a palliative nurse who cared for those dying and in their last few weeks of their lives. When the patients were asked about any regrets they had or anything they would do differently, she found a few common themes and shared her findings in an article which was subsequently turned into a book, The Top Five Regrets of the Dying: A Life Transformed by the Dearly Departing.

Regret 1: I wish I'd had the courage to live a life true to myself, not the life others expected of me

Regret 2: I wish I didn't work so hard

Regret 3: I wish I'd had the courage to express my feelings

Regret 4: I wish I had stayed in touch with my friends

Regret 5: I wish I had let myself be happier

This is a book which I actually enjoyed despite the morbid nature and it helped me in some major decisions in my life, such as whether to quit my job and retire. I will elaborate further in future blog posts as the whole topic of regret minimization coupled with the top regrets of the dying is simply too huge for just one blog post. This is akin to explaining a framework on how to lead your life.

To sum up this post, risk management is the most important portion in portfolio management and possibly life itself. To minimize the risks in your life is to minimize the potential regrets. Whether is it a lifelong regret or a short-term regret like buying that expensive apartment at the peak of the property market. As long as you're aware of the worst case scenario and consequences that could arise as a result of your decision, and how to deal with it when it really comes, your risk/regret can be minimized.