The Perception of Risk

skydivers1.jpgRisk perception is the subjective judgment that people make about the characteristics and severity of a risk.

As I’m writing this piece, a friend of mine and his wife are discussing the cancellation of a holiday to the hill station.. But my friends’ problem is this that an accident took place around the place he wanted to visit a few days back and killing 12 tourists. Now, my friends think that hill roads are too risky to travel on. They are too risky, aren’t they? Well, compared to what?

Human beings perceive and calculate risk in a very non-linear fashion. This may have been OK till prehistoric times but in the modern world, our perception of risk means we are often unable to take the correct decisions in everything from where to go on a holiday to where to invest our money. Savings and investing decisions are almost entirely about how we absorb and process risk-related information and how we balance this out with rewards and gains.

As it happened, when my friends told me about this recent crisis, I had just read an article titled ‘Rare Risk and Overreactions’. It says that human brains are not very good at probability and risk analysis, especially when it comes to rare and unfamiliar events. We tend to exaggerate spectacular, strange and rare events, and downplay ordinary, familiar and common ones. Our brains are much better at processing the simple risks we’ve had to deal with throughout most of our species’ existence, and much poorer at evaluating the complex risks society forces us to face today.

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People tend to base decisions more on vivid personalized detail rather than on information and data. Someone could tell you the accident rate of various types of vehicles at various times of the day and night on various types of roads. Using this information, you could make an informed decision about what is safe and what is not. However, when you switch on the television and witness the sorrow of those who’ve lost family members in an accident, your brain is going to fixate on that individual event and exaggerate the chances of a similar accident happening to you. If something is in the news, you shouldn’t worry about it. The very definition of news is ‘something that hardly ever happens’. Just because TV news covers spectacular accidents but doesn’t cover individual heart attacks doesn’t mean that an individual’s chances of dying of the former are greater.

This reinforcing affect of personal and vivid details works for all kinds of decisions. For example, when you have a salesman of financial products explaining to you how so-and-so made so much money because he followed that salesman advice, you really shouldn’t pay too much attention to the personal details. The right thing to do would be to concentrate on precise data and information about the nature of the investment, the returns it offers and comparisons to available alternatives. I know it isn’t easy to ignore the personal details but at least while evaluating financial details we’d be better off concentrating on hard information and ignoring the happy families in ads. They’re not real people, you know.

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3 Responses

  1. Paul says:

    The only thing I know about risk is that I haven’t pushed mine. I’m here, alive and well, at the cost of giving up many … entertaining endeavors; it’s a choice that I’m willing to make.

    I would never trade liberty for security, but I’m willing to trade entertainment for longevity.

  2. Robin Bal says:

    Hi Paul,

    Thanks for your comment and welcome to Fortune Watch. Not trading liberty for security does make sense, but I don’t know about trading entertainment for longevity.

    What I was trying to convey in this post was the perception of risk related to investments.

    Take care and cheers.

  3. Anna says:

    I think the problem lies in how the information is conveyed. When you talk about making a decision based on a personalization rather than on actual data you’ve pretty much summed it up, for me at least. Many people, including myself are not very good at taking the raw data and making an informed decision simply because it’s foreign to us in terms of understanding what it all means. That’s one of the reasons why we turn to the experts in the field, such as yourself who can then help us evaluate those risks as they pertain to us individually.

    Have a good one!
    Anna

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