Almost all the decisions we make in life involve some kind of risk. In most cases, these are fairly low stakes, but sometimes the risks we take can have serious consequences. When judging the severity of a risk and its outcome, our decisions are subject to emotions, bias and personal perception, which can have a major impact on our lives.
Risk Tolerance and How People Manage Risk
Risk tolerance is a term used to describe a person’s willingness to accept the chance of negative outcomes when making a decision. It’s commonly used in investing. For example, someone with a high tolerance for risk may feel more comfortable putting a larger share of their money into a risky investment.
The tolerance we have for risk varies depending on the person and their own capability of managing the risk. As an example, a person who is less financially secure will normally be more risk-averse than someone who has a higher disposable income. Of course, some people are naturally better at tolerating risk and dealing with the consequences if things go wrong.
Ultimately, risk tolerance is difficult to change, but people who manage risk more effectively often feel more comfortable making decisions that might be considered risky. In investing, risks can be managed by diversifying investments, whereas setting loss limits and time-outs are a good way for gamblers to manage their risk.
Bias and Its Impact on Risk-Taking Behaviour
Despite the capacity of our brains to understand and rationalise, we still often get things wrong due to bias. While we may be intelligent, we still sometimes struggle to make rational decisions when it comes to risks.
A bias is simply an unfair view or belief which isn’t supported by data. It’s very common for us to have biases which we’re often unaware of, usually based around our specific culture or early learning. They have an impact on our decision-making, including risk-taking behaviour.
Confirmation bias, which is where people tend to seek out information which confirms existing beliefs, can have a major effect on underestimating risks. For example, someone who wants to believe that it’s possible for their investment to be successful will take note of people who have made significant profits from similar investments while ignoring instances of others which weren’t successful.
Some people also have what’s known as zero risk bias. This is the idea that all risks are inherently bad and that the potential consequences are much worse than the potential benefits. This bias can lead to people missing opportunities in investing and life due to them prioritising safety over calculated risks.
Short Term vs Long Term Thinking
When making decisions and thinking about potential risks, it’s important to consider both short-term and long-term consequences. Some decisions which prioritise immediate gains might actually create future issues. For example, someone might make investing decisions based on current market conditions, without thinking about how these conditions could change in the future.
Sacrificing long-term stability and growth for short-term gains is generally considered to be poor decision-making when it comes to investing. However, some stock market traders make a living off of short-term gains and reacting to changes in the market. Both strategies can be effective, although long-term thinking is generally less risky.
For many people, short-term gains can seem more attractive because thinking about longer time periods is difficult. However, visualising your future self can help create an emotional connection to long-term outcomes, counteracting the tendency towards short-term thinking.
How Technology Has Made Us Less Risk Averse
Technology has had a major impact on our lives, from the day the first tool was used by our hunter-gather ancestors to the complex machines we rely on today. While there’s no doubt that technology has improved many aspects of society, some feel that it has also increased risk-taking behaviour.
Today, it’s easier than ever to invest and trade on the stock market thanks to stock trading apps. These platforms let users buy and sell global stocks from anywhere, making investing more accessible and potentially increasing the risk that people are comfortable with.
Digital platforms such as the online casino Megaways Casino, the cryptocurrency trading site Coinbase and trading app Robinhood all present different levels of risk. When using such platforms, users are reminded that their funds are at risk, and measures should be taken to ensure they’re not investing or gambling more than they can afford to lose.
