A Childish View of Risk

Figure 1: Teenagers are missing part of their brains. Click the image for full size.

As a parent of three – my kids are 14, 11 and 9 – I try to teach my children how to make better choices.  It’s easy to just tell them “do this” or “don’t do that.”  Sometimes they even listen.  But what I really try to do it have them understand what’s behind the decision – what makes one activity safe and another dangerous.  For those readers who don’t have children, this is much harder than it sounds.  When I say something like “don’t you think that was a dangerous thing to do?” my children’s first reaction is usually something like “but Dad – Nothing bad happened!”  Their justification for taking a risk is that they didn’t get hurt.  “See – I’m OK.”  This is unfortunately a rather persuasive argument in their minds.  A few years ago, Allstate Insurance came out with a full page advertisement shown in the figure about the teenage brain that really impressed me.  Please take a moment to click on the image and read the full-sized text.  …no, really, I’ll wait while you read it…

Isn’t that just amazing?  The words “dorsal lateral prefrontal cortex” appear in an ad, and it’s not some snarky joke ridiculing geeks.  Somebody at Allstate is in tune with Cognitive Science, and I applaud them.  Cognitive Science has begun showing us how the human brain actually works.  It’s a nascent science, but it’s shedding light on an incredibly important topic – how we think, make decisions, behave, convince ourselves of things, and what we do when confronted with information that contradicts previously held beliefs (hint: we’re really good at ignoring it).  Most importantly, Cognitive Science is also revealing how we make decisions in the face of uncertainty – in other words, how we deal with risk.

According to the ad, it isn’t until sometime in your 20’s that you physically get the part of your brain that allows you to make reasonably safe driving decisions.  Heck, we all know people well past their 20’s who regularly make poor decisions, whether they’re behind the wheel or not.  Although the ad implies that “our brains are complete” by sometime in our 20’s, that’s hardly accurate.

The cold hard truth is that sound judgment about risk involves a portion of the brain – the frontal lobe – that matures later in life, is much slower in processing information than the emotional centers of the brain, and all too often doesn’t work just when it’s needed most.  And this is true about all of us — it’s true about me, about you, and even about the smartest person either of us knows.  It’s also true about every single financial portfolio manager.

Plenty of professional risk managers justify their firms’ practices with a statement like “we’ve never had a down quarter” or “our worst month was X.”  How different is that from my children’s plea of “but Dad – Nothing bad happened!” ?  The statement that a financial risk management program has never led to a down quarter is not sufficient evidence that it works.  It merely states that it hasn’t failed (yet?).  The confusion may come from that fact that if a portfolio does have several down quarters in a row, that is sufficient evidence that it doesn’t work.  But the flip side just isn’t true: just because you haven’t had a bad quarter isn’t proof that your approach to risk is good.  You could have been lucky, or you could have had reduced returns.

The next time you find yourself thinking “well, our approach to risk has worked so far” please take a moment and think about that kid standing there in flip flops, sans helmet, holding his bike by its loose handlebars saying “…but Dad, nothing happened the last time I rode down the steep hill!”

One Response to A Childish View of Risk

  1. Loved your post Damian! As a father I could completely relate to the “But Dad! Nothing bad happened” argument.

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