Risk and The [Crystal] Window Metaphor

Approximately a month ago, I finished reading “Good in a Room“. Like most of those books they use real life cases and stories to keep the reader interested. In one of the stories of a “financial advisor”, the author uses a metaphor of a window being broken several times by some kids playing. Maybe it  really “sticked” to me, because of the simple way to describe risk or since it made me remember “the good old days” (I used to break a lot of stuff when a kid.. and still do). Anyways, here is the trimmed version of the metaphor:

Imagine that you have neighbor with a nice patio and kids. The kids like to play baseball and more often than you like, the ball ends up breaking one of your windows. You are getting kind of tired of replacing the window, every time the kids hit a “home run”. So, instead of having a window with one big glass, you could divided in a four piece crystal window (see image bellow) . The next time the ball hits your window, you will only need to replace one of the squares and not whole window.

The metaphor show a way of managing financial risks in your investment portfolio, or even how you should distribute your savings. What if your bank bankrupts today and you have 100,000 USD, but the bank guarantees your deposits up to 35,000 USD. Suddenly, you just “lost” 65,000 USD and it will be some time before you get them back. By distributing your savings in various banks, first you are closer to the deposit guarantee (that each bank might have). Second if one of you banks bankrupts you have your money in the others. Thanks to the this strategy of managing (or distributing) the risk, you hare able to take better decisions, while minimizing lose.

I love it because simplifies risk management and is more appropriate than eggs [analogy]. Although with the eggs and basket you may say, “yeah I can spread my 30 the eggs on 7 baskets”, the analogy doesn’t take into account if you “exaggerate” with the distribution,  is not a good idea as “common sense” may tell you. While you minimizing the probability that all your recourses are lost by distributing your in many places, managing that distribution also consumes resources. If not clear or convinced, lets go back to the window and dividing it in 16 squares. Are you making it more difficult to change a single square or elevating the probability that while putting a new square, the others may break? Well if the window is big enough 16 squares is not bad idea, but if the windows is small, getting those small pieces of crystal can make it a hassle. So depending on the size of the window, the more divisions you have, the higher the probability there is that the structure of the window collapses. The key is to find the sweet spot and that depends on the size of “the window” or more adequately, resources.

Risk mitigation, applies in all sort of discipline, from sports, to business, security and programming. Imagine a startup depending on just a engineer to deliver their product,  a team depending on one player or family in one source of income. This is not that easy, there are some many variables, considerations and can change over time. However the window metaphor, helps simplify and get back to the basics. And is sometimes in those basic things, is where we fail.