Common Cents for September 28th 2012

November 1, 2012, by John Norris

If you read the news enough, you could conclude the world increasingly doesn’t understand the very basic risk/reward paradigm. Essentially, the amount of reward you receive is commensurate with the amount of risk you take. To businesspeople, this makes perfect sense; it is how it should be.

That is how you create wealth: you take risk. It helps if you are insanely brilliant and devilishly attractive, but, where the rubber meets the road, the common denominator I have found amongst all truly wealthy people I know is: they have taken risks along the way. Interestingly enough, they would probably tell you they didn’t even know they were taking the risks they were.

This isn’t brain surgery: we all understand this as individuals. However, when it comes to the economy as a whole, something gets lost in, uh, translation. We want to eliminate risk from the system, and still somehow expect the same rate of return, if not higher.

It doesn’t work that way. When you reduce the amount of risk taken, you reduce the expected rate of return. If your system encourages risk, over time it will become wealthy. If it discourages it, over time your system will lose its wealth.

This is what confounds me about regulations and taxes. Certainly, we have to fund our government, or else we would live in a lawless state. Further, we have to ensure as even a playing field as is possible in order to encourage competition. As such, some measure of regulation and some amount of taxes are necessary.

However, make no mistake: regulations and taxes are costly, and reduce the amount of return a business or a business owner can and/or will make. If they are significant enough, well, investors and businesspeople simply won’t take the necessary risks… September 28 2012 Common Cents