Cousins of Uncertainty, the Interplay Between Luck and Risk

The expression “risk and luck are cousins” became popular through the book The Psychology of Money by Morgan Housel. In his book, the author uses the expression to illustrate the inherent similarities between luck and risk in the context of financial decisions and life outcomes. He explains that luck and risk are intertwined because both are shaped by unpredictable and uncontrollable factors. Despite our best efforts to manage risk or position ourselves for luck, many outcomes are often beyond our direct control.

Here’s a deeper exploration of what this means:

Risk: Refers to the potential for an unfavorable outcome. It’s an uncertainty that can be managed or mitigated through preparation, analysis, and strategy. Risk is typically intentional; we assess it before deciding to act or not. Example: Investing in a new business venture involves assessing market conditions, competition, and the probability of success or failure. I often talk about running an exercise or a wargame as a way to prepare for an unknown future situation and decrease risk by building a “muscle memory” of possible responses. 

Luck: Involves outcomes that are primarily outside of your control. Luck can be positive (good luck) or negative (bad luck). While you can position yourself for opportunities, luck plays a role. Example: Finding a $100 bill on the street is an instance of good luck. Losing your wallet due to a pickpocket is an example of bad luck.

1. Shared Uncertainty: Both risk and luck are rooted in the uncertainty of future events. When you take a risk, you are subject to uncertain outcomes, some of which will depend on luck. Example: Starting a new business involves risk because of market conditions, competition, and demand. However, luck also plays a role, such as securing a great location or unexpectedly favorable market trends.
2. Influence Over Outcomes: By managing risk through analysis and preparation (i.e. risk management), you can improve the likelihood of a favorable outcome. However, luck still remains a factor. While luck cannot be controlled directly, you can create environments that improve your chances of benefiting from good luck or minimizing bad luck. Example: A skilled poker player manages risks through strategy while acknowledging that luck (dealt cards) plays a role.
3. Non-Linear Outcomes: Risk-taking doesn’t always lead to proportional results due to the unpredictability of luck. Example: An investor might carefully analyze a stock but still see unexpected losses due to a sudden economic downturn (bad luck) or unexpected gains from favorable market news (good luck).
4. The Influence of Probability: Assigning probabilities to various outcomes through a risk assessment helps in decision-making. At the same time, luck itself has no measurable probability because it is inherently unpredictable.
5. Interconnected Impact: Positive outcomes influenced by good luck can reinforce the perception of effective risk-taking, and negative outcomes influenced by bad luck may overshadow otherwise sound risk management. Example: An entrepreneur may be considered a genius for a successful startup despite their business plan depending on a lucky break in market demand while another may take fewer risks in the future if they were less successful on an initial venture. 

Understanding the interplay between risk and luck may help you both prepare for uncertainty and also recognize the role of chance in your life. With careful preparation, you can feel confident taking reasonable risks and not being paralyzed in the future when even a well planned bet doesn’t pan out. Don’t be too hard on yourself if you prepared thoroughly and things still didn’t work out. Get back up and try again, now with even greater wisdom!