If you don’t know where you are going, you might wind up someplace else.
—YOGI BERRA
Taking a risk without a goal is just like getting in a car and driving around aimlessly expecting to wind up in a great place. You might land somewhere wonderful, but odds are you’ll end up somewhere you don’t want to be.
We all have days when we want to quit our jobs, ditch our relationships, and start fresh. Most of us know people who’ve done this, and more often than not, the gamble did not pay off. They still faced the same job and relationship issues they did before. In order to have a better job, we need to know what we want from our career. In order to have a better relationship, we need to be clear about what we are looking for in a partner.
Obviously, if you have a destination in mind, you are much more likely to end up there. Yet we often take risks without a clear idea of what we are taking them for.
Risk for risk’s sake can even be a viable political strategy. When the inaction and infighting of traditional politicians frustrates us, candidates often emerge who promise “change” or that they will “shake things up.” This refreshing message appeals to us because the status quo is not that great. Change can be a winning message even if we don’t know what their policies are or what exactly will change. It is no wonder we often end up disappointed, because taking a risk on the unknown for its own sake is a bad risk strategy: it only creates uncertainty without the promise of a clearly defined reward.
It sounds simple, but knowing what you want might be the hardest part of risk management. People spend thousands of dollars on therapists and life coaches trying to figure out what they want out of life. While financial economics is no substitute for good therapy, it offers a method that can help define your goal, which, more than anything else, will increase your odds for a more successful outcome. This three-step process offers clarity and helps assess how much risk you might want to take to reach your goal.
What is your ultimate goal? If you achieve it, what does that look like?
How can you achieve your goal with no risk at all or as little risk as possible? In other words, what would guarantee you would accomplish your goal?
Is that no-risk option possible or desirable? If not, how much risk do you need to take to get what you want?
This process introduces you to a concept financial economists use every day: risk-free. The risk-free option is whatever delivers what you want with total certainty. If you are deciding what to do tonight and your objective is a pleasant evening, risk-free could be staying in and watching Netflix on the couch because you know how that will turn out. Risky is going out. Anything could happen: you might meet the love of your life or get hit by a car.
Risk-free looks different to each person, which is why figuring out what’s risk-free for you provides clarity and helps you value risk. Simply articulating what you want and setting that as a goal is an extremely powerful tool. We often lionize risk takers, but the difference between who succeeds and who fails isn’t who takes the boldest risks—it is who take smart risks, or risks with a clear objective. Take Kat Cole. She went from poverty to leading a billion-dollar company when she was barely thirty. She took what appeared to be one big risk after another to get there, but most of these paid off because Cole always knew exactly what she wanted and when a risk was worth taking.
Kat Cole might seem like someone born lucky. As the COO of Focus Brands, she runs well-known brands like Cinnabon and Auntie Anne’s pretzels. Elegant and well-spoken, she divides her time between her homes in Atlanta and New York City when she’s not traveling all over the world. Most people would never guess where Cole came from and what she had to overcome to achieve such success.
Cole made her name by shrinking Cinnabon’s trademark product, its sugar-filled, buttery cinnamon roll. The original, beloved bun—all 880 calories of it—is the size of your face and absolutely delicious. Cole was thirty-two years old when she was hired in 2010. Cinnabon had had six years of net sales decline. The recession kept people out of malls and airports, and consumers claimed they wanted healthier choices. Cinnabon needed to shake things up: enter Project 599.
Project 599 aimed to reduce calories in the traditional Cinnabon with a product that clocked in under 600 calories. Research showed that offering lower-calorie alternatives could increase sales, but cutting calories required making a roll full of artificial sweeteners and stabilizers. Cole, who had been president of Cinnabon for barely a year at the time, killed the initiative. The new roll did not taste as good. She kept the original recipe instead and mandated that all franchise owners offer the 350-calorie MiniBon, a smaller version only the size of your fist. The petite rolls already existed, but fewer than 15 percent of Cinnabon stores sold them.
Franchise owners were skeptical. Cinnabon was famous for its large size. If the company sold a smaller version, it would have to offer it at a lower price—$2.50 instead of $3.60. If enough existing customers chose the mini instead of the original, it could mean smaller profits. The mini also required investing in new baking equipment. Cole believed that the smaller rolls would increase volume because they would attract new customers who didn’t want a face-size cinnamon bun. She convinced franchise owners to take the risk and bet on volume. Her risk paid off: sales of the original barely dropped while overall sales rose 6 percent, due in large part to the mini. Cinnabon thrived, while similar fast-food companies floundered or failed.
Cole had a clear objective in mind: increase sales. Everyone at Cinnabon agreed on the problem: the high-calorie original roll didn’t sell well in a more health-conscious market. Cole started by asking why Cinnabon was trying to reduce calories, and the executive team told her that “there was all this research that sales went up with a lower-calorie alternative.” But “those were high-frequency snacks, like potato chips; no one eats a cinnamon roll every day,” Cole explains. “That’s not our model. We are in infrequent venues, like malls or airports. Our products are designed for the once-in-a-while, blow-your-socks-off indulgence. This was a problem because an artificially sweetened roll wouldn’t be as yummy and it is still 599 calories.”
Somehow the low-calorie option—not higher sales—had become the objective. Cole drove the point home by asking the people working on 599 “if they’d buy a 599-calorie roll that didn’t taste good [and] everyone said no.”
Cole says that when people need change they often “take a risk for risk’s sake.” This rarely goes well.
Doubling down on the decadence of a Cinnabon appeared to be a bold move for Cole, who was much younger than almost everyone she worked with. She was new to the company and new to fast food. Meanwhile, the rest of the fast-food industry was still trying to figure out low-calorie “healthful” menu options. At the time, choosing to stick with a calorie-dense/high-calorie product seemed like a major risk, one Cole bet her career on.
You can see the concept of risk-free at work in Cole’s decision process. First, she identified the goal—increase sales in a changing market. Notice how she avoided the option that stymied her competitors—create a healthy alternative. Doing nothing might appear to be risk-free, but it would not achieve her goal because sales would continue to decline.
Then Cole hit upon the lowest-risk option that would increase sales. Her colleagues had thought a diet pastry was the answer because everyone else in the industry was offering low-calorie versions of their products. But Cole saw that path as a bigger risk because a new product was not guaranteed to increase sales and risked diminishing the brand, which was all about quality and decadence.
So if a new product wasn’t the solution, then “the only way to reduce calories was to be smaller or have different ingredients,” she explains. The smaller roll was already on the market; some franchises had been selling it for almost a decade. Working with an existing product rather than changing the recipe of a beloved product was actually less risky than it seemed, especially because there was evidence from some franchises that the smaller roll would sell, and it did not compromise the company’s reputation. Based on the data, adding the smaller cinnamon roll was the least risky way to go if the goal was to increase sales, and it worked. Within a few years, revenues doubled and Cinnabon became a billion-dollar brand.
Cole learned about managing risk by making unconventional choices early in life. She had a chaotic childhood with an alcoholic father. Her dad earned a decent living, thanks to a good white-collar job, which was unusual since both sides of the extended family lived in trailers and shacks. With no way to support herself outside of the relationship, Cole’s mother made the tough decision to leave, taking her daughters with her. She worked multiple jobs, while keeping the family on a tight $10-a-week food budget for four people and relying on young Kat, the eldest, only nine at the time. Armed with a list of tasks, Kat ran the household, and in the process learned that taking risks often means you need to “work your butt off” to make it happen. “I could not have known the valuable business lesson it was at that time. The belief it was possible to make unpopular and nontraditional choices and have it work out.”
Cole chose a stable career path, majoring in engineering at the University of North Florida, with aspirations to be a corporate lawyer. To support her studies, she worked as a waitress at Hooters, the restaurant chain famous for uniformed waitresses in tight shirts and orange micro shorts.
Cole was a great waitress. When the bartender couldn’t work because her son was sick, Cole tended bar. When the kitchen staff walked out because the chefs wouldn’t work overtime, Cole fried the wings. When Hooters corporate asked the manager who was the franchise’s best employee, the manager named Cole. Hooters needed someone to go to Australia and train employees at a new franchise, so they asked Cole. “I said yes, to go to Australia. I didn’t have a passport; I’d never been on a plane; I’d never been out of the country. But I still said yes and then I worked my ass off.”
Cole thrived in the role and soon Hooters was flying her all over the world to help set up new franchises. But her schoolwork suffered and she started failing classes. She had to make a choice: drop out of college and give up on her dream of becoming a corporate lawyer or stop traveling for Hooters.
Both Bill Gates and Mark Zuckerberg dropped out of college, and they became billionaires, but Cole wasn’t dropping out of Harvard with powerful and connected friends, nor did she have an affluent family to fall back on. She wasn’t going to Silicon Valley, where dropping out of college is considered by some to be a badge of honor. In her world, college was the surest path to success and stability, and she would be giving it up to be paid hourly at Hooters. It may sound like a risky decision, but Cole’s goal was to get a good job one day and achieve the security and stability she lacked as a child. At first, she thought that meant practicing corporate law, but then she realized that being a lawyer was not the ultimate goal—it was just one way to get there. And someone was offering her a path to what she ultimately wanted, even if it was not the way most people got it. She dropped out. Not everyone would have seen this so clearly; to many of us it would seem like a risky choice.
Cole was able to see that dropping out was the right decision because it felt right, and it turned out to be low-risk for her objective. “It was not that difficult a decision and not one that felt that risky because I had a compelling alternative,” she remembers. “I wasn’t sitting around thinking . . . mmm . . . I am not sure college is for me. . . . I’ll do something else. I was traveling around the world and was good at it. . . . I was doing something I loved, I had an opportunity to keep doing it, but there were no guarantees. I had no contract. I was an hourly employee. No one sat me down and said this is your career path; you can bank on this. But it was so right.”
Cole worked so many hours she managed to pull in $45,000 a year. Eventually, Hooters corporate headquarters offered her a salaried job for $22,000 that she accepted because it was her chance to climb the corporate ladder to an executive position. Cole rose through the ranks and was an executive vice president by the time she was twenty-six. She may have been a college dropout, but the sort of companies that usually hire only Ivy League graduates were now trying to recruit her for high-flying jobs in private equity and management. She stuck with Hooters, “even though it was sort of embarrassing every time I handed someone my business card.”
Even though she did not have an undergraduate degree, Cole eventually earned an MBA. By 2010, she was a star in the restaurant industry, and she got an offer that was too good to turn down, the chance to run Cinnabon.
Cole’s early choices might have seemed risky at the time to outsiders, but she owes her success to taking risks in a smart way. Her success comes down to being good at identifying her goal and the least risky way to get it. She didn’t think twice about dropping out of college or yanking Project 599. For most of us, the path is not always so clear.
Knowing what you want is hard, especially when you know change is what you need. In financial economics, the first step is to identify your goal and price it in risk-free terms. There is an investment known as the risk-free asset that offers investors something no other asset can: predictability. In finance, risk-free promises a certain payoff no matter what happens. If markets crash, you know what you’ll get paid. If markets boom, you only get paid what you were initially promised. The price of that risk-free asset is the most critical piece of information in any investment problem, or any decision, you might face.
Suppose your family’s vacation next summer will cost $3,000. If you need $3,000 in the near future, you should invest your vacation money in a safe place; you won’t want to lose a dime in the market. It could be a simple savings account or a Treasury bill. Each offers a set interest rate for a certain amount of time. To have about $3,000 when summer rolls around, you would need to invest $2,970 at 1 percent interest for one year.
Risky, in this case, is everything else—long-term bonds, stocks, gold, Bitcoin—all of which offer a much higher expected return and a chance your $2,970 will be $6,000 in six months. But there is also a chance markets will crash and you’ll only have $500 for the family vacation.
If your goal is $3,000 for a vacation next year, your risk-free option is the savings account that pays 1 percent interest. Figuring this out before you invest serves two important functions.
First, it helps you gauge how much risk you need to take to achieve your goal. Suppose someone offers you an investment that is guaranteed to double your money in one year (actually, you should run far away and warn all your friends and family to avoid this person—but for the sake of argument let’s assume this offer is legitimate). If this investment really exists, there is no need to risk losing your money in the stock market, and you only need to save $1,500 for your family vacation. The risk-free rate puts a cost on getting what you want for certain. If you only have $1,500, you can’t afford risk-free, so you can either take more risk or take a less expensive vacation.
Second, and more important, the process of defining risk-free helps to clarify your objectives. Defining what risk-free means to you forces you to think through what you want and what will happen when you get it. The 1 percent return is how much money you will have in one year. If you have $2,000 today, it will be $2,020 next year; if you have $2,970, you know you’ll have enough for your vacation.
But it can be hard to see the risk-free choice because there is no single universal risk-free asset; it depends on your goal. For most of us, dropping out of college would be risky. But for Cole, dropping out of college was a lower-risk choice than years of school and debt to be a corporate lawyer, because she had a specific goal in mind—an executive job—and someone was offering her a way to get it when she was nineteen. Articulating your goal and putting a risk-free price on it are the first steps of good risk taking.
Risk-free is different for everyone because it depends on your goal. That’s true even in finance.
Suppose you want to take your partner on the trip of a lifetime when you retire in twenty years. You estimate it will cost $30,000.
Having $30,000 in twenty years, risk-free, is more complicated. You need to make sure you don’t lose the money in markets and that your savings keep up with inflation. If inflation averages 2 percent a year* for twenty years, $30,000 today will only be worth about $20,000 when you take that trip. The bank account you use to save for the family vacation isn’t risk-free for a twenty-year investment because the interest rate it pays probably won’t keep up with inflation. The risk-free financial asset for the retirement vacation is a twenty-year bond that ensures your investment return keeps up with inflation.
Defining our goal in risk-free terms can help us gain clarity in any life decision. We all have friends who desperately want to get married and figure that the risk-free way to achieve this is to marry the first person who loves them dearly, even if they don’t return the feeling. In fact, they feel safer because they assume this person will never leave them, so they’ll never get hurt. But often their marriage lacks a strong mutual connection and is not hardy enough to weather life’s challenges, and they divorce. If simply getting married is their goal, then it is a risk-free choice to wed the first person who loves them. But if their goal is being married, then settling is a high-risk choice.
Consider another life decision: Suppose you find your dream house in a hot real estate market. If your goal is getting that specific house, the risk-free option is putting in a large bid, maybe above the asking price, as much as you are prepared to pay (assuming you aren’t paying more than you can afford)—to ensure you get it. This will eliminate the risk of being outbid, even if you overpay. If this is the only house you love and plan to live in for the rest of your life, overpaying is the price you pay for the certainty of not losing a bidding war.
But if you want to get a good bargain to make money on this investment, or if you plan to sell the house in the foreseeable future, then your goal is different, and so is your risk-free strategy. If the goal is paying as little as possible instead of getting that one perfect house, then you should bid less than what you think the house is worth and be comfortable with the risk of losing a bidding war. Otherwise you risk overpaying and losing money when you sell the house.
People often confuse the two goals and underbid on a house they really want or else get caught up in the market frenzy and pay too much for a house they plan to sell in five years.
Suppose you are thinking about taking a new job. You are comfortable in your current job; you have an understanding boss who lets you leave early when you need to be home; and you’ve mastered the skills your position requires. If your goal is advancing your career or earning a bigger salary, then staying in your present job won’t get you what you want and may even be riskier than making a switch. Changing jobs forces you to broaden your network and learn new skills, all of which can enhance your career, boost your earnings, and make you more employable in the future. But if your goal is work-life balance, leaving is a big risk since your new boss may not tolerate the other demands in your life. Mastering the new skills and company politics requires putting in more hours. The risky choice depends on your goal.
Often we must balance competing objectives—a house we love and got for a good price, a stable career that offers both work-life balance and an opportunity for advancement. But first thinking through what you are looking for and putting it in risk-free terms helps you to refine your goal and acknowledge how much risk you are willing to take.
Anyone can take a risk. But doing so with a clear goal takes conviction and focus. It requires knowing exactly what you want, and few of us do. One of Cole’s favorite catchphrases is to focus on things that are “small enough to change but big enough to matter.” In other words, take the lowest-risk path to achieve your goal.
Figuring out what we want and putting it in risk-free terms should be the first step in assessing any risk problem. But sometimes, perhaps most of the time, we identify the low-risk choice and it isn’t what we want or we can’t afford it. Take the dream-house example: If you can’t afford overpaying, you have to take the risk of losing the bidding war. The following chapter explores the next step, figuring out when to take more risk.