Considering Financial Risk & Judgment

Judgment is a mere lottery, sometimes you are right, and sometimes you are wrong. For most of us it is more likely that 2% of us are right 50% of the time; and, even if I am wrong, which is most likely, the odds are not very good even if 50% of the population are right most of the time. Benjamin Franklin, the author of Poor Richard’s Almanac, wrote, “At twenty years of age, the will reigns; at thirty, the wit; and, at forty, the judgment.” Luckily, research is identifying specific actions, to help those of us who are judgment challenged at any age, to make better decisions.

A new field has emerged over the past few decades that may hold the key to unlocking how we evaluate and determine the appropriate course of action in making a broad range of economic decisions. This new discipline is called behavioral economics, and studies the impact of our decisions on our lives.

Today, people, typically, consider our economy in one of two possible ways: some people are saying taxes are too high and regulations are stifling the economy; thus, businesses have no incentive to invest or create new jobs; while, others are saying: demand is too low, if wages were higher, consumers would buy more and businesses would then produce more and hire more employees. But, in a new book entitled Think, Fast and Slow by Daniel Kahneman, suggest a different factor is at play. He describes how our judgment and levels of risk taking affects our behavior. The book presents a number of interesting experiments, conducted by Dr. Kahneman and his colleagues, to understand how people make decisions. Kahneman’s findings indicate our minds operate in two distinct ways: one is fast and emotional, while the second is slower, study and more logical. The former is more uncertain in its decision making and obsessive. The latter is slow in making choices. Each day we use these two forms of thought, shifting from one to the other, without even thinking about it. Situations determine our choices, but, just as often, external factors can stimulate one method of thinking against the other.

One chapter, entitled “The Engine of Capitalism”, will probably be of interest to business owners because it focuses on “the blessing and curse” of optimism. Kahneman’s studies show that people, typically, exaggerate their ability to predict the future. This leads people to believe their goals are achievable when, in fact, they are not even closely obtainable; in the same way, personal confidence leads many of us to become entrepreneurs when statistically a little over a third of the small business startups survive the first five years in operation; while, almost two-thirds of those who start a small business believe they will succeed!

A positive attitude does have advantages: it breeds endurance in the face of obstacles, it tends to enhance the chances you will be an effective leader that enables you to motivate employees and close deals. Entrepreneurs energize people to provide money and resources to expand and development new businesses, and create enormous growth in our economy. Without a group of positive thinking, risk takers, our economy would have less growth, our society would have less innovation, and our citizens would certainly have a lower standard of living.

All this is good, in small doses, which is why a variety of small businesses are beneficial to our country, the failures are small enough to be absorb by the economy; whereas, misguided optimism by large business owners or government executives, who use our money to invest in high risk projects that fail, cause extraordinary losses and negatively impact our economy. The point is: we recover from many small failures that are spread over the country-side. Whereas, one very large, complicated project can have a huge financial impact on our economy when it fails.

So, go slow, realistically evaluate your options, tackle projects in manageable proportions, and don’t believe everything you read or hear about yourself; stay optimistic in relationship to your capabilities and the limitation of your resources.