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Complexity vs. Risk - Don't get confused when attempting to understand or mitigate risk

9/30/2019

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Too often, people mix up the ideas of risk (or riskiness) and complexity - they aren't the same and they shouldn't be mixed up. When you don't understand the difference between the two, you're liable to make errors in judgment and/or decision-making related to your investing portfolio, your career, and even your overall life. 

Complexity in our current context is when things are complicated, multifaceted, and difficult to grasp mentally in an all-encompassing way. Complex things need to be broken down to be understood, but they aren’t necessarily probabilistic (or stochastic) in nature.

Risky things, however, could be complex or they could be simple – there is an overlapping area where things are both risky and complex, but risky things definitely don’t need to be complex. Risk arises when there is a probabilistic (or stochastic) distribution of outcomes, some of which are unpleasant or detrimental in some way.

The reason people often mix the two up is because understanding and dealing with complex things requires mental energy – this means a human needs to exert real mental energy to deal with, process, or utilize complex things/concepts. This can be inherently unpleasant, since the conscious mind seems to want to be in a constant state of pleasant ambivalence and rumination (this rumination has a way of often becoming quite unpleasant, but that’s for a different day). Our minds might simply shut down in a sense when dealing with complex things, similar to how they’d shut down when working through risky things from a probabilistic sense.

The problem arises in that it makes a lot of sense to break risky things down into their underlying probabilistic components (assuming these components can even be understood), but it doesn’t always make sense to break complex things down in such a way if you’re only concerned about risk. It only makes sense when the complex things are risky; if they aren’t risky, there’s no reason to break things down to understand risk. Some mental discipline and clarity could help you take a few steps back and see the bigger picture. Ask yourself if this complex thing is in fact risky – if it is, analyze; if it isn’t, step back and don’t get bogged down in unnecessary details if your primary concern is risk-related.

The simplest things in the world (for example, whether the stock price will be above or below a certain strike price X) can be incredibly difficult to understand from a risk perspective. But, things that appear incredibly complex in their operation nature (for example, the fault rate of complex self-driving software) might be very simple from a risk perspective. In the self-driving example, maybe you only care about the error rate, which can be easily determined (and probably already has been by the firm producing the software) and utilized in downstream analyses, calculations, etc. 
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