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When investors lose on a stock, the hurt they feel is greater than the pleasure of another stock rising an equivalent amount. Consequently, investors are too risk-averse and miss out on gains enjoyed by unusual individuals with ice water in their veins.
Buying when they feel confident and selling when they feel fear, many end up buying high and selling low, and that is a guaranteed losing strategy. Successful investors are greedy when others are fearful and are fearful when others are greedy, as Warren Buffet phrased it.
The problem is that most investors are human beings, and natural selection favored excessive caution if it helped our remote ancestors to survive. When it comes to the game of investing, we merely stand to lose money. In the game of life, we stand to lose our lives.
Risk-Averse Brains
Nervous systems evolved as movement control devices. Animals move mainly to feed, to reproduce, and to avoid danger. Of these motives, avoiding danger is the highest priority, because individuals that fall prey to predators leave few offspring.
The brains of all mammals have an alarm system—known as the reticular activating system—that alerts them and rouses them to movement whenever they sense a threat.
This fight-or-flight response is one of the key components of our emotional lives and helps explain why we are so risk-averse. Nervous prey animals, such as rabbits, disappear into cover at the slightest sign of danger. They do so on many occasions when there is no real threat, because risk-averse rabbits were less likely to get taken by surprise, and therefore survived to leave more descendants.
Humans had natural predators also, such as lions, tigers, and pumas. As a result, we evolved fairly risk-averse brains. Our level of anxiety is certainly a function of our biological heritage, but it is also sensitive to our experiences early in life.
This phenomenon is reflected in the effect of poverty on the willingness of children to put effort into education and careers.
Poverty and Fear of Failure
Among the many possible disadvantages of being raised in poverty, children have lower aspirations.
They are content with satisfying their basic needs and do not want to accomplish great things in their work lives.
This lack of ambition is often analyzed in terms of fear of failure. Children having a high fear of failure shy away from difficult challenges and mostly satisfy themselves with simple goals that are easy for them to accomplish.
The lower ambition of children raised by impoverished parents reflects parental behavior. The parents spend very little time reinforcing children's efforts on difficult tasks. Instead, they punish them for failures. As a result, these children avoid activities that they perceive as difficult so as to prevent failure. As adults, they pursue short-term goals over long-term ambitions and engage in impulsive behavior, such as spending recklessly with little thought for the future.
Why poor parents socialize children in this way is a neglected topic, but it seems likely that they are preparing their children for a future in which their aspirations are only as high as those of the parents need to be.
The bottom line is that if we have a strong fear of failure, we are rather unlikely to pursue long-term projects, such as founding a new business.
Social Democracy and Business Risk
This phenomenon has recently come to the fore in the conclusion that people are more likely to start businesses in modern social democracies, such as those of Scandinavia, compared to the U.S.
This is more closely related to the contingencies of adult life than to childhood experiences.
Residents of Europe's social democracies, such as Norway and Sweden, are more likely to take the plunge of starting a new business than Americans are.
This cannot be because they are more strongly inculcated in the merits of capitalism and free enterprise. The most plausible explanation is that residents of these countries benefit from the safety net of a social welfare system that protects people of all ages from hunger, ill health, and homelessness.
This means that the downside of entrepreneurship is less daunting. If the business fails completely, they do not fear losing their homes, living on the street, and dining out of trash cans.
Conversely, residents of many other developed countries are afraid to give up their jobs and work on a risky new business with the loss of income security and health insurance.
They follow a basic principle built into the brains of most mammals and vertebrates. If the environment is risky or dangerous, proceed with caution, but exploit whatever resources are readily available.
