The strategy around investing is, to some extent, about fear and responding to fear. In the Oxford dictionary, “fear” is defined variously as:

  • Painful emotion caused by impending danger
  • Anxiety for safety
  • Having uneasy expectations

and all of these definitions resound within each of us. Neuroscientist & neuroeconomist Dr. Gregory Berns from Emery University in Atlanta in his book, The Iconoclast, would say that there are many different categorizations of fear. Fear leads to stress, and neurologically, the stress response has two components — neural and hormonal. In turn, the neural component has two parts — sympathetic and parasympathetic. The former provides quick response to danger—the infamous “flight or flight” reaction…. instantaneous action without thought…. “Beam me up, Scotty”. The latter is more useful in combatting the debilitating impact of long term stress.

The amygdala is the part of the brain that processes fear and emotional responses. It has a long memory and, thus, retains memories of past bad experiences. There are ways to manage the amygdala’s processing of fear. The answer is, first, to reframe the situation to a non-emotional context, and then, second, to reframe the fear into assessment of risk. This moves the brain’s processing away from the amygdala. Then, the third step is to reframe the assessment of risk into ambiguity and statistical uncertainty, the latter of which can be measured by mathematical probabilities. This process moves us from emotional reaction to logical action.

In his book, Risk Intelligence, Dylan Evans says that people have differing degrees of risk intelligence. He defines the term as the ability to estimate probabilities accurately. He posits that most people simply associate the term “risk” with “danger”, whereas those who study risk professionally also associate the word with “opportunity”. A high level of risk intelligence is not attainable without a high tolerance for ambiguity. “Catastrophizing” sees the glass as always half-full, and focusing on all the things that can go wrong. The statistical concept of “expected value”, identified by Pascal and Fermat in the 17th century, mathematically combines probability with outcome, in order to give greater perspective to the uncertain event. Chronic worriers tend to measure only outcome, not expected value. “Worse-case thinking substitutes imagination for thinking…speculation for risk analysis…and fear for reason”. Evans outlines a four-step approach to shift from an outcome-based decision style to one of expected value. Addressing probability to embrace expected value requires fact-gathering. This process can be faulty though, as we filter out facts that are inconsistent with our a priori inclinations. The wise approach is to deliberately seek out a diversity of opinions, especially those contrary to your own, and to incorporate them into your probability assessments.

Evans likens risk assessment to a parabola, where the top of the left side represents complete certainty of the outcome -“I fully believe this will happen”- and the top of the right side also represents complete certainty- “I fully believe this will not happen”- and the bottom represents complete uncertainty (ie 50/50)- “I haven’t a clue what will happen”. Risk intelligence hangs out on either slope of the parabola…. the more likely world, where an outcome is somewhere between “certain knowledge and complete ignorance”.

In one sense, going through life is a giant inner game of “knowing oneself”. This game has an all-important knock-on effect to financial fitness. “Gnothi seauton”, as the Greeks say.

Article Published 10-Sep-13