Human Beings Are Generally Terrible At Evaluating Risk

One of the first steps when we get to the investment planning portion of the financial planning process is to evaluate a client's risk tolerance. Since risk and investment returns tend to go hand-in-hand (generally, in order to realize a greater return, one must accept more volatility, loosely defined as the risk of loss), financial planners like me tend to throw a variety of charts, forms, and questionnaires around all in the goal of ascertaining what sort of fluctuations a client can tolerate in their portfolio.

If there is one thing I've learned in conducting hundreds or thousands of these interviews, it's that our species is pretty awful at evaluating risk. It's not your (or my fault) - I think it's the way that we're programmed. It's important to realize that this flaw leads us to some incorrect conclusions as to how to handle these risks.

Our fear of shark attacks are a perfect example of our species' idiosyncratic approach to risk. Per year, approximately 10 people die worldwide due to shark-related accidents and attacks. I don't mean to make light of the fact that these are real people with real lives, but it is important to keep the risk of death by shark attack in perspective relative to other, far greater threats to our livelihood.

Meanwhile, about 10,000 - or 1,000 times more people per year - die of death by freshwater snail, yet we don't have a Freshwater Snail Week on the Discovery Channel. About 25,000 more die due to rabies transmitted from a dog, about 50,000 due to snake attacks, and 725,000 die due to mosquitoes (mostly from malaria).

We're 47,500 times more likely to die at the hands of another human than by a shark.

Data from the World Health Organization, by

Yet people will let a disproportionate and sensationalized fear of sharks affect their behavior. This affects many other parts of our lives as well.

Ever see a parent drive their child to school?

Between 1999 and 2010, about 22 children aged 5-14 tragically died of bus-related accidents (non-pedestrian, and presumably, but not solely, in school buses). Meanwhile, during the same time period, 13,757 kids died of traffic-related (car, truck, motorcycle, non-pedestrian) accidents (data according to the CDC).

Thus, an overconcerned parent is literally increasing their child's mortality rate about 625 times by driving them to school instead of letting them take the bus.

Why do they do this? Think about the coverage associated with a school bus accident, surely to be national news, both during and after the incident, and the impact that it has on your thinking. The image of a smashed school bus sticks inside of your brain. It's horrifying to think about this for all of us, even us without kids. Fear leads to action - I'll drive my kids to school, and that way I'll make sure that they get there safely. The illusion of control.

Yet school bus accidents are extremely rare (hence, why it makes news when it does unfortunately happen). There really is no safer vehicle than a gigantic, tank-like visible yellow school bus travelling down the road, stopping at every railroad crossing. If you have to travel at 30-50 miles per hour, that seems like the safest way to do it, with or without a seat belt! In comparison, the humble and practical minivan can be cut in half or smashed into pieces by a drunk driver in a heartbeat. This happens every single day and it rarely makes the national news unless it happens to a celebrity.

That's why it's best to refer to the data before making any risk-related decisions. We can't fully control our fear-based reactions, but the best way to compensate for our natural and behavioral biases is by combating them with data and logic. This applies to transportation as well as investing.