Risk is a constant in our lives. Some say the constant is change, but don’t these two go hand in hand?
Some people are better at handling risk than others, but human psychology often prevents us from perceiving risks correctly. We sometimes become paralysed – like the proverbial deer in the headlights – when exposed to risk. Other times, risks appear lower than they really are as we fail to fully grasp them.
There’s also a socialising effect on risk perception. If you have travelled in an airplane, you will have heard the airhostess warning about the “unlikely event of a water landing”. This is terrifying to hear for the first time, but when you hear it every time you fly, you start discounting the risk. But has the risk really changed? Obviously it hasn’t. Catastrophic risk probabilities tend to be tiny and can lull one into thinking the risk doesn’t exist.
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An IPO prospectus clearly spells out the risks for a company. It even mentions how many court cases are pending against it. But when things are so upfront, people yawn and move on. They are only thinking about how much they can make from the IPO – risk factors be damned! This behaviour goes beyond humans. A lamb fed sumptuously for months by the butcher, for instance, tends to discount the menace of the sword he carries.
Point of view affects risk perception
Ever had an experienced driver by your side when you’re behind the wheel? You may have heard them ask you to drive carefully, avoid the pothole, and slow down as you may hit the car ahead. It’s annoying for sure, but this is another example of how risk looks different depending on your point of view.
Stock market speculation looks risky when others do it. But when you do it, it does not seem risky at all – you even call it an investment!
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Trying to mitigate risk by going with the group is common human behaviour. It’s an easy heuristic for people who’d rather not use their minds to solve the problem at hand. They go with it as they feel safe, even if the decision carries a lot of risk. That is why mobs do things that no individual would do on their own. Being in a group gives people a sense of security and lowers risk perception.
The need to believe
Risk also seems lower when dealing with marquee companies. How many times have you accepted terms and conditions that run into dozens of pages without even reading the first line? That’s because we assume that a large, professional company will not do anything to jeopardise its customers and thereby its own future.
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However, corporate malfeasance does happen, and most big companies are notorious for having one-sided contracts. There is risk, but we don’t perceive it as we think the company won’t stoop that low. How naive of us! Risk can also seem lower when it’s mixed with mundane information. A typical contract, for instance, has many adverse clauses that are placed innocuously in the inner pages.
In the end, risk is a strange concept – a mixture of perception and reality. Often, our tendency to mistake one for the other is the real risk!
Suresh Sadagopan is MD & principal officer at Ladder7 Wealth Planners and the author of ‘If God Was Your Financial Planner’.
