It’s fairly well known that our ability to assess risks is diminished when we’re tired, stressed or our mental reserves are otherwise depleted in some way. New research from Caltech and Yale highlights how uncertainty in our life also affects our ability to assess financial risks.
“An old idea we build on is that you should not look at small odds in isolation,” the researchers say. “In real life, you’re never facing choices that are isolated. There is always other risk and other uncertainties that you are facing at the same time.”
The researchers cite the example of getting your car insured, and argue that even the relatively small risk of losing one’s car becomes less pertinent if you’re also grappling with high levels of background risk.
“Say you are 22 years old and all you have is this car,” they explain. “Buying insurance in this case makes sense—but not so much if you are in a place in life where bigger things are at stake: your hair is graying out, you start having health problems, and you are worried about your investments in the stock market, where you might be winning or losing $1,000 every week.”
In context
The authors argue that when you have lots of other risks going on in life, then you can often prioritize them, which can render small gambles less important.
The researchers attempted to use maths to improve how we can make these kinds of choice. They explain that the domain of individual choice has been one economists have steered clear from, but in areas where financial loss could result, it’s perhaps wise to try and nudge people in the right direction.
One approach could be to use averages to better assess various options, as this could help to better highlight the expected losses and gains.
The authors believe that their work highlights the ways in which our choices can be both understood, but also improved upon if we’re nudged in the right way.
“The idea of making bets based on the average goes back hundreds of years. It is a crude approach for making decisions, and reduces a risky option, however complex, to a single number,” they explain. “Nevertheless, what the new study surprisingly shows is that choosing small gambles according to their average is perfectly reasonable.”
It’s not quite clear whether they have included the distorting effects of stress on our decision making, but given the increasingly complex nature of our daily lives, the insight into how we can effectively make decisions is still of interest.
