Evolution and understanding risk

Scream “snake” in a crowded place and you can see many people jump up. There is an evolutionary response that pumps adrenaline to create a fight or flight response when we see “traditional threats”. Let’s contrast this to the number of people who ride bikes without helmets or drive cars without wearing seatbelts. The chances of getting into a traffic accident are much higher than being bitten by a snake but still the responses are disproportionate.

Our genetic programming makes us consume in excess so that it can be stored to enable the body to sustain in times of severe shortage of food. But modern life has made that severe shortages of food rare (in most societies). All of us understand this intellectually but many of us are victims of over-eating more often than we’d like.

This is not to say that everyone is irrational, it’s just that our genetic programming does not make us well equipped for the challenges of modern day life. We need to understand these lacunae and have strategies and discipline to manage them.

Nassim Taleb cites a very interesting example in his book “Antifragile”. Let’s say there are 2 brothers, one is a clerk in a large firm and the other one is a cab driver. Both of have similar incomes. We instinctively think that the clerk has a lower risk as his salary is more assured, while the cab driver’s income can vary on month on month basis. We tend to ignore that the clerk is exposed to a risk of job loss, which means that there may not be any income for him in the down cycle. Whereas the cab driver may earn less in a down cycle but will still continue to have some income. This does not mean that people who are in a job need to panic, it just means that they need to understand that they are exposed to an event risk and prepare themselves. They could do this either by putting away some funds for an emergency and/or building up skills or alternate incomes so that they will be able to tide over a tough period.

People tend to spend more when they are using a credit card or when they borrow, as opposed to paying cash. This again does not mean that everyone should move away from plastic, but to be aware of this and be conscious of over spending when one is using plastic. Research does suggest that people who are having serious challenges controlling their spending on credit cards are better served by switching to cash purchases.

Many people have bulk of their assets locked in their house but forget to purchase or renew their homeowners insurance. Earthquakes, fires are rare events but they represent a significant risk as this will have a significant impact if the risk materializes. It may be prudent to purchase homeowners insurance, especially for people whose house represents significant part of the assets.

 

 


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About Praveen Reddy

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