Risk and Variance
Risk isn’t just “bad things happening.” It’s the range of possible outcomes—and your exposure to the ones that matter.
Key Distinctions
Risk vs. Uncertainty
Frank Knight’s foundational distinction (Knight, 1921):
| Type | Definition | Example |
|---|---|---|
| Risk | Known probabilities | Coin flip: 50/50 |
| Uncertainty | Unknown probabilities | Will AI take my job? |
You can calculate risk. You can only estimate uncertainty.
Variance vs. Expected Value
Expected value: The average outcome if you repeat something many times. Variance: How much outcomes scatter around that average.
Same expected value, different variance:
- Option A: Always get $100
- Option B: 50% chance of $0, 50% chance of $200
Both have $100 expected value. Option B has higher variance. Which is “better” depends on context.
Tail Risk
Most outcomes cluster around the average. Tail risks are the rare extremes that can be catastrophic.
| Domain | Tail Risk | Mitigation |
|---|---|---|
| Health | Cancer, accident, chronic disease | Screening, insurance, safety habits |
| Wealth | Job loss, market crash, lawsuit | Emergency fund, diversification, insurance |
| Social | Relationship breakdown, reputation damage | Maintenance, boundaries, integrity |
| Meaning | Burnout, depression, crisis of purpose | Rest, connection, professional help |
Rule: Avoid ruin. You can recover from bad outcomes. You can’t recover from catastrophic ones (Taleb, 2012).
Cross-Domain Risk Framework
Evaluate Before Acting
- What’s the expected outcome? (average case)
- What’s the variance? (range of outcomes)
- What’s the worst case? (tail risk)
- Can I survive the worst case? (ruin check)
- Is the upside worth the downside? (asymmetry)
Seek Asymmetric Bets
Good asymmetry: Limited downside, unlimited upside
- Learning a skill (time cost, career upside)
- Starting a side project (small investment, potential big return)
Bad asymmetry: Unlimited downside, limited upside
- High-leverage speculation
- Ignoring health for work
Decision Criteria
Take more risk when:
- You’re young (time to recover)
- Downside is capped
- You have margin (emergency fund, health buffer)
- Upside is large relative to downside
Take less risk when:
- Failure means ruin
- You’re responsible for others
- Recovery time is limited
- You’re already exposed
Related
- Tradeoffs — Risk is a cost
- Asset Allocation — Managing financial risk
- Constraints — Risk tolerance as a constraint
The goal isn’t to eliminate risk. It’s to take the right risks—ones with asymmetric upside and survivable downside.