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From: Carl Richards <carl@behaviorgap.com>
Sender: "Carl Richards" <carl=behaviorgap.com@mail83.atl11.rsgsv.net>
Date: Thu, 19 Jun 2014 19:05:31 +0000
To: bob<mainandwall@gmail.com>
ReplyTo: Carl Richards <carl@behaviorgap.com>
Subject: Behavior Gap: How Risk Savvy Are You?
| | How good are you at assessing risk? Do you consider yourself risk savvy? Or do you feel like you're always guessing about what you should do?
I ask, because a couple of weeks ago, I saw an interesting Q&A with Gerd Gigerenzer on this very subject. He's the director of the Center for Adaptive Behavior and Cognition at the Max Planck Institute for Human Development in Berlin. He recently published a book titled, appropriately, Risk Savvy: How to Make Good Decisions.
I haven't read the book yet, so I can't speak to whether it's good or bad. But his answer in the Q&A to a question about why it’s important to be risk savvy caught my attention: “It is a precondition for a functioning democracy that people should not be easily frightened into surrendering their money, their welfare and their liberty. Risk savvy means being able to understand the basics of statistical reasoning. But that’s not enough. In a world of uncertainty you need rules of thumb, called heuristics. You need both those tools. … We live in the 21st century, surrounded by complex technology, and there are things that we will not be able to anticipate. What we need is not just better technology, bigger bureaucracy and stricter laws that limit individual freedom, but risk-savvy citizens.” Re-read that last sentence (emphasis added). Now, think through what it could mean if we were better at assessing risk. How much easier is it to behave if we have a better understanding of risk? All too often, I see people failing to understand and accept the risk they've taken. For instance, a certain group of people will always be shocked that a portfolio invested 100 percent in stocks turns out to be riskier than a portfolio with a mix of stocks, bonds, and cash. They were so sure the risk was minimal!
Risk will never be zero. After all, even eating comes with the risk of a one in 3,842 chance of choking on your food and dying. Yet, we still see people eating every day, and they don't look particularly scared. So why are we so bad at measuring risk in other areas of life?
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My theory is that the more emotion we feel about something, the less confident we feel about our ability measure risk in real terms. For instance, we feel a lot of emotion about things that scare us physically or about issues involving a lot of uncertainty. It's why we're pretty good at not worrying about choking to death on our food, but why we believe the odds are high we'll die if struck by lightning (the chances are only one in 126,158).
Few things will help us behave better than becoming more risk savvy and understanding real risk versus emotional risk. To start, I suggest looking at a couple things: - What information are you using? There are plenty of competing opinions out there, which leads to misinformation. Before you decide to go one way or the other, double-check the information you're using to make a decision. Have you found the best source of information or gotten distracted by something that's popular, but not as accurate?
- Do you react or think through the issue first? Sometimes, our instinct will be to do something right now, particularly if we're feeling pain. If the situation involves a hot stove, this reaction makes perfect sense. If it involves a down day or two in the market, not so much. Understand when you're better served to think first and react later.
Becoming risk savvy won't happen overnight, but I agree with Mr. Gigerenzer that there's no reason to think we can't get better at it.
Carl
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