In the late seventies, Hebrew University psychologists Daniel Kahneman and Amos Tversky discovered that humans have an outsize dislike for misfortune. When the two researchers asked test subjects to risk $20 on a coin flip, they found that those subjects needed a reward close to double that figure to make the gamble palatable. The existence of this irrational biasknown as "loss aversion"has since been confirmed in study after study. If you stake out the rental-car counter at the airport, you'll find folks paying $40 a day for insurance they don't need, even when they know their own auto coverage (not to mention their credit-card company) will protect them. If you examine stock-market transactions, you'll learn that peopleeven professional money managerssit on shares on the decline for twice as long as shares on the rise.
It seems we can't help but worry about taking a hit, no matter how small. Odder still, the more we fixate on our lossesreal or perceivedthe more we're willing to risk to make amends. Back in the mid-nineties, when Nick Leeson was the general manager of the Singapore office of a British investment bank called Barings, one of his underlings made an error that cost the company $30,000. Leeson decided not to report it. He tried to hide the loss in a secret account instead. He figured he could make up the difference with a little trading of his own. He bet that the Nikkei would go down; it went up. He bet that Japanese government bonds would go up; they went down. Playing double or nothing time and again, Leeson compounded his predicamentraising the deficit from $30K to $30 million to $200 million. He ultimately rolled up $1.3 billion in losses, driving Barings out of business.
So how do you avoid blowing up the bank when your job's on the line, your budget is shrinking, and your boss insists that you find a new source of revenuepronto? On one hand, fear can improve your focus and sharpen your senses in preparation for a fight-or-flight challenge. On the other, it can make you stupid, shrinking your working memory and distorting your sense of risk. Well, it helps to understand fear's mysterious ways. Here's what the smart guys do.
BE PREPARED TO CUT BAIT: It's easy to get attached to projects that you've poured time and energy into, but if they're obviously going nowhere, it's smarter to drop the ax yourself than wait for someone else to do it. The anticipation of a negative outcome tends to be more unpleasant than the outcome itself. Likewise, if you're worried about your year-end bonus, go ahead and ask if it's going to be slashed. "You might not like the answer," says Stanford University psychologist Brian Knutson. "But at least you can get on with your life."