A realistic assessment of risk is key to investing, as it is to any business transaction. However, it is something that we humans are not terribly good at. Our emotions, attitudes, biases and preconceptions get in the way, distorting our views and affecting our decisions. You only have to think of the fear many people have of flying, when getting into a car presents a significantly higher risk to life.
Which raises an intriguing question: could gambling hold lessons for investors? I’m not for a moment suggesting that investors should gamble with their savings. Investment risks are more complex and hence more difficult to assess, and they’re generally - unless you’re investing in a Ponzi scheme - much lower than gambling risks. But might the principles be the same?
A quick question: if you flip a coin and it lands heads five times in a row, is there an improved chance that on the sixth flip it’ll land tails? Konnikova cited a study that compared the investment performance of professional investors and lay people. The professionals generally fared worse than the lay people, and this is because they had become overconfident in their abilities, and when market conditions changed, they had difficulty in adjusting to the new conditions. The lay investors did not have the same attitude and “went with the flow”.
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