If I was to watch the world news every day I would be filled with a burning desire to build myself a hut in the hills, don my hazmat suit and wait for the impending collapse of humanity.

I met a guy who’d done pretty much that. He was Welsh and drunk most of the time. But once, in the local pub he’d decided to venture into after spending a year living in solitude, he confided in me that all the things that had driven him to his fearful state didn’t seem all that important any longer.

He told me this as he glanced occasionally at a TV above the bar, where David Attenborough was magically making a previously boring looking swallow seem like the most amazing creature you’d ever seen. Perhaps he realised that the world in fact wasn’t in quite so terrible a state as it seemed to be if you took your information from the 6’o clock news.

Indeed, media studies indicate negative news reports outweigh positive news reports by 17 to 1!

Given a 17:1 barrage of mayhem, death, destruction, and Tony Blair this poor miserable Welshman was on the brink of hanging himself, and a little quiet time providing perspective had brought him back from the brink. Sure it hadn’t cured his drinking problem but then again he was Welsh.

[drizzle]I bumped into him again a month or so later and he’d taken up a regular spot in the pub playing his guitar. Apparently he was pretty good because the bartender told me he’d spent the previous night being ridden around his bedroom by some South American backpacker wearing a cowboy hat who must have mistaken him for Jon Bon Jovi. He had a glint in his eye that wasn’t there before. This perspective and media diet had clearly changed his world for the better.

The reason for this poor sod’s previous state of fear can be explained by an almond-shaped mass of nuclei deep in the brain’s temporal lobe – the amygdala. According to men in white coats who play with rats and still wear Brylcreem this highly sensitive part of our brain contributes heavily to threat detection.

From an evolutionary and neuro-scientific perspective we are hardwired to look for dramatic and negative news and when we find it, we share it.

The clansman who spotted a sabre-toothed tiger would immediately share the information with his clan. Being eaten was a pretty big deal and you didn’t want to be the guy explaining to Joey’s wife as she sat grieving over his mauled body that, “Ah yeah, now you mention it, I did see that horrid beast up on Woolly Mammoth point just yesterday. I guess I should have mentioned it to him. Sorry about that.”

Social sharing of danger was therefore immensely important.

Today, however, we don’t wait to catch up with Billy for a drink on the weekend to tell him about the car crash on the highway that we just drove past. We snap it on our smartphone and post it on a dozen social media sites where it is then re-posted and shared by hundreds of others, thus amplifying the visibility of the crash.

The fact is that unless you live in Kandahar, or maybe Detroit, unusual scary things just don’t tend to happen that often to most people. If you live in a small town of a few hundred thousand people it’s a big deal when someone is murdered.

On the other hand, when you have a murder in a city of a million plus people it’s just a fact that you’re more likely to hear about it. Take a city like New York and London with over 8.5 million people, or Shanghai with 25 million; there are a few murders going down and they will be blasted all across the 6 o’clock news.

Many studies have shown that we care more about the threat of bad things than we do about the prospect of good things. Our negative brain tripwires are far more sensitive than our positive triggers. We tend to get more fearful than happy. Clearly taken to its extreme this can result in radical emotion driven decisions which don’t produce positive results.

An Experiment

In a now-famous experiment done by two researchers, Amos Tversky and Daniel Kahneman, they examined how people make decisions involving risk. These gents were working in an area of research known as behavioral finance but the results can be extrapolated to any actions involving risk.

In their experiment subjects where provided the following scenario:

  • Suppose you have been given $1,000 and must choose between a sure gain of another $500 or, alternately, a 50% chance to gain $1,000 and a 50% chance to gain nothing.
  • Another group of subjects were given a different scenario: You are given $2,000 and must choose between a sure loss of $500 or, alternately, a 50% chance to lose $1,000 and a 50% chance to lose nothing.

Both situations are identical in terms of the net financial benefit to the individuals but Tversky and Kahneman found that most members of the first group chose the sure gain of $500. A majority of the second group, however, opted for the gamble between a loss of $1,000 and loss of nothing.

The simple phrasing of the question – the fact that one is presented in terms of gain and the other in terms of loss – is what causes them to be interpreted differently?

The conclusion of the experiment, which has been proven many times since was that people are willing to run greater risks to avoid losses than they are to make gains.

Next week I’m going to discuss how this ties into another mathematics principle uncovered centuries ago by an Italian mathematician and how most investors focus on the completely wrong sectors and asset classes at the wrong times.

We’ll top if off with a subscriber-only report on the 8 investment biases that screw with your investing that a good friend of mine and part of our global network put together.

Until then, have a fantastic weekend!

– Chris

“An investment said to have an 80% chance of success sounds far more attractive than one with a 20% chance of failure. The mind can’t easily recognize that they are the same.” – Daniel Kahneman

Risk Management Lessons From A Drunk Welshman

[/drizzle]