Investing and the Danger of Selective Risk Assessment

Suppose you were thinking about getting a dog. Before going out to get one, you decide to do some research on whether or not it’s a good idea to have a pet dog with kids in the house. The first thing you come across is a story about a dog mauling a young child to death. The story is so disturbing and dramatic that you decide right then and there that no dog is going to come into your house! Or, suppose you’ve written that great American novel and are thinking about whether you should find an agent or just self-publish your work. The first thing you read is a story about an author who self-published his work and sold tens of thousands of copies within the first year. So, you take it upon yourself to pay for all the editing, design, and promotional materials involved in publishing your own work.

It’s very possible that you could have gotten a dog that violently attacks your children but, based on existing data, it’s far more likely that your dog will simply be a great companion helping your kids through their childhood. On the other hand, it’s possible that your self-published novel could go on to be a best-seller. But, without some serious hard work and dedication, the odds–based on the vast majority of people who have tried–are that your story will quickly fade into obscurity. These simple examples highlight a problem in decision-making that stretches across all domains. People have the tendency not to consider the sum of all possible outcomes when making choices. Instead, they only think about the closest, most dramatic piece of information—causing them to ignore all the data they need to make a truly informed decision.

The practice of selectively evaluating risk is more dangerous in the world of investing than it is in perhaps any other area. When you’re putting your hard-earned dollars into the market, you want to be sure you’re getting the big picture and not just what the pundit on TV was talking about in a sound bite from the morning’s news. Stories sell. They’re convincing to us. The more dramatic, the more persuasive.  But if you want to be a great investor, you’ve got to put your skeptic’s hat on and consider all of the risk—not just the toned-down version that the financial advisor is pitching you. Always remember that old standby: if it’s too good to be true, then it probably is.

Just because somebody somewhere else in the world got lucky, that doesn’t mean that you will. Every day, in the world of investing, someone takes a foolish gamble and wins big. Those people are exceptions, though. The rule is this: that success is achieved by thoughtful, deliberate, and disciplined behavior over a long period of time. If you’re interested in learning about how to become a successful investor in a way that will actually work, feel free to reach out to us for a complimentary consultation. We want to help you wade through all the dramatic stories to find the information you really need to become the investor you want to be.