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Premortem

I used to think risk and probability were the same thing.

After all, on the surface, they look identical:

There’s a 20% probability we are successful.

There’s a 80% risk we lose our initial investment

However, the key distinction is that probability is solely related to the percentages, while risk is more connected to the expected value.

What the heck does that mean?

Let’s add some more numbers:

There’s a 20% probability that we are successful and make $100

There’s an 80% risk that we lose our initial investment of $1

Is this a different situation than the following?

There’s a 20% probability that we are successful and make $1

There’s an 80% risk that we lose our initial investment of $100

Absolutely, and it comes down the “Expected Value”. Here’s how to calculate it:

Expected Value = Sum (Outcome * Probabibility)

Let’s calculate the Expected Value for the first situation:

Expected Value = 20% * $100 + 80% * (-$1) = $20 - $0.80 = $19.20

And the second:

Expected Value = 20% * $1 + 80% * ($-100) = $0.20 - $80 = -$79.80

The higher the chance of loss and the higher the loss, the higher the risk.

You may not be able to change the odds, but frequently, you have power to change the loss.

In other words, you can have a low probability of success, but it can still be an incredible idea worth pursuing if you can just limit the potential loss.

chess

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