Understanding Risk Management: Lessons from Andy Grove
Risk management is a hot topic in both academic and practical business circles, yet there’s no single definition of “risk.” For our purposes, risk refers to the possibility and extent of permanent financial loss. To grasp effective risk management, let’s examine the work of a corporate risk management expert, the late Andy Grove, who passed away on March 21, 2016.
Andy Grove was a co-founder, former chairman, and former CEO of Intel Corporation, a company renowned for its high-quality computer chips. Grove also authored one of the most influential business books, Only the Paranoid Survive: How to Exploit the Crisis Points that Challenge Every Company. This book not only became a business classic but also offers valuable insights into personal finance, investing, and career management.
Grove was known for his intense attention to detail, a trait he expected from his employees as well. This meticulous approach has been a significant factor in Intel’s long-term success.
From a personal finance standpoint, being detail-oriented means having a clear understanding of your monthly spending habits and the terms of any credit you use, such as mortgages, loans, and credit cards. Wise spending and conservative use of credit are fundamental to both corporate and personal financial responsibility.
In personal investing, being detail-oriented involves closely monitoring the performance of the professionals you’ve hired to manage your money. Remember, these individuals work for you, and it’s your responsibility to track their performance over time.
Grove’s concept of “paranoia” also has significant implications for career risk management. Consider this excerpt from the preface of his book:
The sad news is, nobody owes you a career. Your career is literally your business. You own it as a sole proprietor. You have one employee: yourself. You are in competition with millions of similar businesses: millions of other employees all over the world. You need to accept ownership of your career, your skills, and the timing of your moves. It is your responsibility to protect this personal business of yours from harm and to position it to benefit from changes in the environment. Nobody else can do that for you.
Many people have suffered financially and psychologically because they haven’t embraced the idea that “your career is literally your business.” This includes union workers facing volatile hiring cycles and older employees laid off during their peak earning years.
A central theme of Grove’s book is that “things change,” and sometimes these changes are substantial. Every significant change has winners and losers. Over time, the winners are those who embrace change and find ways to make it work for them. Those who wait to be carried along by change risk being left behind and suffering financially. From a career risk management perspective, this means everyone should have both a career development plan and a backup plan.
Career development planning involves enhancing your technical or professional skills. This can include taking select trade, technical (such as computer and software), and business courses (such as finance and accounting). If you can’t afford a course, consider asking your employer to cover the cost. Alternatively, many schools allow you to audit courses for free or a minimal fee.
Regular coursework not only expands your knowledge but also helps grow your personal network, which is crucial when seeking new job opportunities.
Having a career backup plan means outlining specific actions you’ll take if you suddenly lose your job. Whether you’re a blue-collar or white-collar worker, having a backup plan is essential because change is inevitable. Andy Grove understood this and benefited from it both professionally and personally, just as we all can.
The Benefits of Caution: Mitigating the Risks of Greed
You don’t have to be as “paranoid” as Andy Grove to achieve success, but a healthy dose of caution can be beneficial, especially when it comes to mitigating the risks associated with greed. Greed—an intense, self-absorbed desire for wealth—can drive behaviors that generate significant personal finance risks. One notorious example is the Bernie Madoff Ponzi scheme.
We’ve had numerous discussions about Madoff’s scheme. One individual we spoke with was approached to invest with Madoff in the early 2000s but wisely declined. When asked why, they responded, “It was long assumed that Madoff was ‘doing something’ illegal, likely ‘front-running’ (where traders place their own trades ahead of their clients’). We don’t do business with people like that.”
When we mentioned that many successful and high-profile people invested with Madoff, our friend offered a direct and insightful response:
Successful and high-profile people can be greedy just like everyone else. Many of them probably thought Madoff was a crook, just like we did, but they mistakenly thought he was ‘their’ crook. In other words, they let their greed override their judgment. It happens all the time, unfortunately.
Later that evening, an episode of American Greed aired on television, profiling several elderly individuals who invested all their retirement savings in a dubious scheme that turned out to be fraudulent. We wondered why these people risked everything, and the program provided an answer. One of the profiled individuals said, “I should have known better. I just got greedy.”
It’s natural to desire wealth. Who doesn’t want nice things? However, many people assume that being wealthy means living a life of leisure and being worry-free. While this may be true for some, it’s certainly not the case for all wealthy individuals. For instance, we know several highly successful professional investors. While each has a unique personal style, they share many professional traits.
One of the most prominent traits is their strong work ethic: these professionals, and their staff, work far more than 40 hours a week. Theirs is definitely not a life of leisure.
Another common trait is their acute sense of risk. Investments can lose money for various reasons, and these professional investors work diligently to identify and monitor all potential causes of loss. In fact, some attribute their long-term investment success to how intensely they worry about and monitor the risks associated with their investments.
Seven Strategies to Mitigate the Risk of Loss Due to Greed
Here are seven practical steps you can take to mitigate the risk of loss due to greed:
- Be Cautious with Your Money: Remember, you can’t be defrauded if you don’t hand over your money to a fraudster. Always be extremely careful about who you trust with your finances.
- Avoid Unethical Individuals: It’s a simple fact that unethical people can’t be trusted. If you find yourself in an investment or personal finance relationship with someone dubious or unethical, end it immediately.
- Question “Risk-Free” Opportunities: If you’re presented with a seemingly “risk-free” investment opportunity, ask why you’ve been targeted with it. Professional investors usually keep great ideas to themselves to maximize their profits.
- Consider Professional Help: Unless you have ample time to carefully screen potential investments and perform intensive due diligence—which involves much more than simple Google searches—consider hiring a professional money management firm.
- Opt for Large Firms: Absent a very compelling reason, only hire large money management firms. Large firms tend to have substantial assets and ample insurance to protect those assets in case of lawsuits.
- Monitor Performance: No matter who invests your money, carefully and continuously monitor their performance. If things go off-track, take timely action to make corrections.
- Guard Against Greed: Everyone has the potential to be greedy, so be vigilant about not letting it cloud your judgment. One way to do this is to be on the lookout for and avoid Ponzi schemes.
By following these strategies, you can significantly reduce the risk of financial loss due to greed.
Navigating Investment Risks: Lessons from Ponzi Schemes
The 1920s saw a booming stock market that seemed to promise easy money. It was during this era that Charles Ponzi orchestrated a fraudulent investment scheme that would forever bear his name. In recent times, Bernie Madoff executed the most notorious Ponzi scheme, leading to his arrest in 2008 and his subsequent passing in prison on April 14, 2021.
Despite widespread awareness, Ponzi schemes continue to find victims, lured by promises of superior returns often packaged with compelling financial narratives. A 2020 article in CNBC Markets reported that the value of Ponzi schemes had reached its highest level in a decade, signaling a troubling trend.
It’s important to note that Ponzi schemes can affect numerous individuals, and they’re not the only form of financial fraud that can devastate personal savings. The financial scandals that led to the collapse of Enron and Worldcom in the early 2000s also wiped out many individuals’ savings.
To protect yourself from fraud in general, and Ponzi schemes in particular, consider these guidelines when evaluating investment opportunities:
- Adopt radical skepticism: Emulate successful professional investors by maintaining a highly skeptical mindset throughout your investigation of an investment opportunity. This approach can help you resist being drawn into a fraudulent narrative.
- Question why you’re being targeted: If your net worth is less than $5 million, you generally shouldn’t be approached for speculative investments, nor should you participate in them.
- Benchmark performance: Compare the investment’s performance to established benchmarks like Berkshire Hathaway or the S&P 500. If it significantly outperforms these benchmarks, investigate why. Remember, the chances of finding “the next Warren Buffett” are extremely slim.
- Limit your exposure: If you decide to invest, only commit a small amount that you can comfortably afford to lose. Never risk your home, livelihood, or entire savings on a single investment.
- Act quickly if fraud is suspected: If you believe you’ve been defrauded, contact the authorities immediately. Swift action may increase your chances of recovering your money and bringing the fraudster to justice.
With the recent coronavirus pandemic and recession, there’s potential for more frauds to be uncovered. As the saying goes, “When the tide goes out, it’s easier to see the trash.” In light of this, it’s important to revisit the lessons from notorious frauds like Bernie Madoff’s to better protect yourself in the future.
Lessons from Madoff’s Victims: Safeguarding Your Finances
Several years ago, a book titled The Club No One Wanted to Join: Madoff Victims in Their Own Words was published, offering valuable insights into personal finance and investing from the victims of Bernie Madoff’s Ponzi scheme.
Some of Madoff’s victims were retirees who had paid off their mortgages and were living comfortably. However, to increase their investment portfolios, some re-mortgaged their homes to invest more money with Madoff. One victim explained their decision:
In the spring of 2003, I decided to renovate my small but comfortable Florida condo that was completely paid for. The advice given to me by my sage uncle and another financial advisor was to take a “little extra” out in a loan and move it over to Bernie. “Don’t tie your money up in bricks and stones; have it out there working for you. You’ll earn more with Bernie than the bank will charge you in interest.” So, I did just that and started making monthly mortgage payments.
This decision proved to be a grave mistake. Your home is not just an investment; it’s where you and your family live. It should never be put at risk unnecessarily.
If someone advises you not to “tie your money up in bricks and stones; have it out there working for you,” remind them that you want your home to remain a stable and comfortable place for you and your family. Then, consider ending the conversation, as they may be overconfident, uninformed, or even a fraudster, like Bernie Madoff.
Additionally, many of Madoff’s victims had all their money managed by him. If they had diversified their investments, their savings wouldn’t have been completely lost. However, their confidence in Madoff led them to entrust all their money to him.
Fraudsters like Madoff are called “confidence men” for a reason. They often wrap themselves in respectability. Madoff, for instance, was a former chairman of the NASDAQ stock market, was investigated and cleared by the Securities and Exchange Commission (SEC) multiple times, and was authorized by the Internal Revenue Service (IRS) to be an Individual Retirement Account (IRA) custodian. Many victims felt the government effectively endorsed Madoff, which gave them the confidence to entrust him with all their money.
It’s important to understand that complying with governmental rules and regulations is a basic requirement for businesses. This compliance does not equate to a government endorsement. When an investment business meets these minimum requirements, it doesn’t guarantee the competence or knowledge of the money manager. Therefore, abnormally good investment results, like those reported by Madoff for years, should always be skeptically and thoroughly evaluated. If you lack the skills to do this, avoid investing with that money manager, even if trusted advisors recommend it.
Managing risk is a broad topic, and we’ve covered a lot of ground. By learning from the experiences of Madoff’s victims, you can better safeguard your finances and make informed investment decisions. The importance of vigilance, skepticism, and diversification cannot be overstated when it comes to protecting your financial well-being.
