Without risk there is no return

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Key point

  • Grain & Graze has developed a price guide to help growers and advisers understand the risk of different commodities and how they relate to each othe

The influence of the head, heart and gut on a decision

The head is the logical, rational processing of information, the calculations and some realities we can face such as a financial position, age or health.

The gut is intuition, shaped through experiences and knowledge. It allows us to make quicker decisions because it bypasses rational processes by linking past experiences and knowledge (both good and bad) with the present. Intuitive decisions are about ‘feel’.

The heart captures the emotional aspects of a decision. They are value-based and include a grower’s goals, beliefs and preferences. Put simply, they are a guidance system for decision-making.

SOURCE: AgCommunicators

There is no reward without risk. In farming, risk is a necessary part of making returns. As individuals, we can influence how much risk we expose ourselves to by making choices.

Managing risk is about making decisions that trade some level of acceptable risk for some level of acceptable return for an acceptable amount of effort. Decisions can be made to reduce risk, but it usually comes at a price – namely, lower returns.

Growers accept that risk is a part of farming and have developed long-term strategies and operational tactics to cope with this challenge. Common strategies include diversifying enterprises, increasing integration, marketing strategies and even mixing up property location. Managing input costs is an important strategy, especially when production and prices can be highly variable.

The word ‘risk’ is derived from the Italian word ‘risicare’, which means ‘to dare’. When we think about risk most of us immediately think about negative consequences, but risks also provide the opportunity for upside or a greater return.

Everyone has a different position on risk. Financial security, stage of life, health, family circumstances, business and personal goals can influence the amount of risk an individual is willing to take on. This position can change rapidly, sometimes triggered by sudden events. Importantly, no position is right or wrong; it is what the individual is comfortable with.

Average is not normal

Managing risk is not about the middle or the average. It is the opposite: appreciating what happens at the extremes, the size or value of these extremes and how often they occur.

Average values are commonly used to talk about yields, prices and costs, but the average is not the most common outcome. For example, the long-term weekly price for Australian Premium White (APW) wheat in Geelong port from July 2003 to June 2016 was $292 per tonne, but we only get this price (plus or minus $5) 4.3 per cent of the time. Most prices are not evenly distributed around the average (Figure 1), they are skewed. If we use averages for analysis, we usually overestimate the profits and hide the volatility in those profits.

The Grain & Graze program has developed the Ag Commodity Prices tool* to help growers and advisers understand the volatility, skew and correlation around different commodities.

Figure 1 Frequency of different prices for APW wheat at Geelong port (July 2003 to June 2016)
Graphic showing frequency of different APW ehat prices at Geelong port (July 2003 to June 2016)

SOURCE: AgCommodity prices, Grain & Graze 3

Making choices

The choices we make are influenced by three areas: the head, the heart and the gut. Most growers analyse risk by using their gut, as they intuitively know that choice A is riskier than choice B. Grain & Graze builds on this intuition by providing numbers to help ‘frame the odds’ of certain outcomes occurring.

Considering risk is only one aspect of making a good decision. A good decision is an informed decision, where you appreciate the consequences of various actions, have the least regret if it does not go according to plan and an increased chance of a favourable outcome. A right decision can only be judged in hindsight. The Grain & Graze program has developed several approaches to help make good decisions, some of which are showcased in this section of the GroundCoverTMSupplement.

GRDC Research Code NRS00009

More information:

Cam Nicholson, Nicon Rural Services,
03 5258 3860,
cam@niconrural.com.au

Grain & Graze 3 (click on tools)