How to Worry About the Right Things

As human beings we are really bad at deciding what to be afraid of. We often are afraid of things that are not harmful at all to us, while simultaneously being completely unafraid of things that may actually kill us.  In between these two extremes we often misjudge which risks are more risky, and more likely to occur, and which risks are less risky, and less likely to occur.

Your Money and Your Brain

Here's a few questions taken from Jason Zweig's book Your Money and Your Brain which illustrate this problem: If we look at the answers it can be quite illuminating.

The worst nuclear accident occurred at Chernobyl, Ukraine, when their reactor melted down in 1986.  Although initial early estimates said that tens of thousands of people might be killed by radiation poisoning, fewer than 100 people had died as of 2006.

On the other hand skin cancer kills 8,000 Americans every year.  Skin cancer is most commonly caused by overexposure to the sun.

In a typical year, deer are responsible for approximately 130 human deaths in the US, which is more than 7 times more than alligators, bears, sharks, and snakes COMBINED.  Deer don't kill people with their horns however, they just step in front of moving vehicles, causing deadly collisions.

Finally, most people think that wars cause the most deaths on this list, and they think homicides kill more people than suicides. In most years however, it is completely the opposite.  Suicides are almost twice as common as homicides, and far more people die from conventional homicides than from war.

Given these facts, why are so many people afraid of Alligators and snakes, when it's Bambi they should be worried about?  Why are so many resources devoted to catching murderers, when it's suicides that are killing the most people?  And why do protesters show up in droves to protest nuclear power, when it's the sun that is killing people by the thousands?

None of this is to say that nuclear radiation isn't harmful, murderers aren't scary, and a snake won't bite you if you step on it. But the likelihood of those things happening is often grossly overestimated by us.  That's because fearsome images of murders, animal attacks, and nuclear meltdowns are easier to imagine, and therefore easier to remember and more likely to be foremost in your mind when assessing the probability of bad things happen.

Misfortune Caused By Fear

Daniel Kahneman, the Nobel prize winning psychologist explains that "we tend to judge the probability of an event by the ease with which we call it to mind."  The more recent an event or the more vivid the memory is in our mind, the more likely we are to predict it happening again. Ironically, and very unfortunately, much of our world's misfortune is actually caused by our own fear.  

Driving is much less safe than flying in an airplane. You're about 65 times more likely to die in a car crash then a plane crash, even when adjusting for the distance travelled.  In 2003 only 24 people died in commercial aircraft in the US while 42,643 people died in car crashes.  In fact, in the 12 months after the attacks of September 11, 2001, there was a demonstrable increase in the number of people driving rather than flying. This led to an estimated 1500 ADDITIONAL deaths in car crashes, which is more than the number of people actually on those planes that crashed on September 11.

This irrationality often applies to our behaviour towards our investments as well.  Stock market crashes are emotional, and create vivid and painful memories.  These are easy to recall, and therefore seem more likely to happen to us.  In a survey of investors, people said that there was a 51% chance that the stock market would lose a third of its value in any given year.  And yet historically there is actually only a 2% chance that will happen.  

Meltdowns in Stock Markets

Stock market meltdowns do happen, and they even happen somewhat regularly, but the odds of a drop of that magnitude in a year is pretty remote.  On the other hand, investors lose millions of dollars every year in purchasing power as inflation chips away at their savings.  While everyone is busy trying to avoid an economic Chernobyl, it's the skin cancer of inflation that is actually killing them.

Whenever you invest, it is important to be as rational and dispassionate as possible, so that you can properly assess the risks you are taking on.  This is crucial so you can decide WHICH risks you take on and HOW MUCH risk you take on.  All investing involves some risk.  So called 'risk-free' investments like GICs or government bonds have tremendous inflation risk and interest rate risk.  They are far from risk free.  

Anyone who treats them as risk free is underestimating the risk they are taking on, a decision which could lead to disastrous results for that investor.  This does not mean that stocks are not risky, or are less risky than bonds.  It depends on the circumstances at the time, and your own personal goals and objectives.  Nevertheless, it is certainly true that bonds or GICs can be risky, and under certain circumstances can be even more risky than stocks.  

It is certainly arguable that a 30 year government bond with a current interest rate of 1% is a riskier investment than a share of Berkshire Hathaway.  I would say you are much less likely to lose money after inflation on your Berkshire Hathaway stock over the next ten years then on that government bond, and over 30 years it is a virtual certainty that Berkshire Hathaway stock will outperform that bond. This kind of thinking is not always conventional in financial advice.  

Nevertheless, as we can see above, conventional thinking often is very wrong about what is most risky, and what isn't.

-  Craig White, BA, LL.B., CIM

Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.