Why did a very successful Coca-Cola ever launch New Coke? Why did people invest their kids’ college funds in Beanie Babies? Surely anyone could have seen these efforts could only end in ruinous failure. Hind sight is 20/20 because human beings are, more often than not, blind to seemingly obvious risks. Srini Pillay, M.D., of NeuroBusiness Group outlines three reasons for poor risk assessment in his HBR blog.
First, reward obscures risk. When on a roll we often throw caution to the wind and go for the gold. A good example of this involves former Enron employees. Their 401(K) plan featured a wide array of investment options including Enron stock. Their company matching contribution was in the form of shares in Enron. An absurdly high percentage of employees put ALL of their personal contributions in Enron stock. When the company failed, they were wiped out. “Don’t put all of your eggs in one basket” is an ancient caution. Why did they do this? Our brains tend to ignore signals of danger when presented with reward. Las Vegas was built on this defect. Dr. Pillay says we should routinely ask: What is my winning preventing me from seeing? Probing for this answer can help negate the reward drive.
The second involves sunk costs. Why do so many people buy more shares of losing stock they already hold? Believe it or not, some people were still buying shares in Polaroid long after it was clear the company would succumb to the onslaught of digital photography. It turns out that many of us excel at avoiding recognition of loss. The best way to overcome this blind spot is to develop the discipline of recognizing and accepting loss rather than ignoring it.
The third reason is what Dr. Pillay calls “future aversion”—the problem of assuming that because the future is unknown it cannot be tested. Many people simply rely only on present data rather than trying to forecast the unknown. This is compounded because of our strong motivation to avoid punishment due to errors (even though studies show that punishment improves learning after an error). Dr. Pillay advises small steps with limited risk to test out ideas before leaping forward. He also notes that intuition can help us “know” things about the future that we do not know consciously. Testing out hunches is usually not a bad idea.
Roman generals on parade during a Triumph in Rome would be attended by a slave on the chariot with him whose job it was to repeat ” Remember, you are but a man and not a God” It turns out we need to develop inner voices to avoid unnecessary risk.