Risk isn’t really linear

It’s easy to talk about things which are “higher risk” and “lower risk”… and most of the time it’s appropriate. Last week Tom Loosemore used the idea well, and I’m sure we’ve all used that concept at one time or another.

But we should be aware that risk (or “uncertainty”, if we’re to include positive as well as negative outcomes) isn’t usually linear. That is, it’s not always the case that one thing is simply more or less “risky” than another. In most conversation this isn’t important. But if we’re basing big decisions on uncertainty of one option versus another then having this deeper understanding is valuable.

To illustrate this we have to consider that most outcomes are not binary success/fail outcomes, but rather exist on a range covered by a probability curve. Here’s a rough picture which shows that. It’s some option we’re considering that has the chance of a positive outcome (a gain of up to £200k) and a negative outcome (a loss of up to £100k). We can see that we’re more likely to get a positive outcome (the area from £0k to £200k is greater than that below £0k) but there is a chance of some negative outcome.

Now let’s overlay it with the possible outcomes from another option we might be considering:

This second option has a smaller chance of a negative outcome (the area under its curve is smaller on the negative x-axis) but we could lose more—up to £150k, compared to £100k with our first option.

So which one is “higher risk”?

I don’t think there’s a single right answer here. If we have to choose between doing one or the other we have to consider our situation more broadly. That includes looking into each option, seeing what contributes to the shape of its success, and seeing what action we could take to change that more in our favour.

To repeat what I said at the start of this article, most of the time it’s entirely appropriate to say one thing is higher risk than another. But we should be aware that’s not always the case, especially when these are big decisions. Although that may seem to complicate things we can use that as a reason to get together and discuss and understand our options much better, and then take more appropriate actions to improve our likely outcome.