Investor Fears

Startups

“I want the cake and eat it too”

Wish we were all Adam Smith’s economic man. Someone, who can think and act rationally at-least where economic matters are concerned. After all, economics is about facts and figures and decision making should follow that rationale

Unfortunately, as most behavioral scientist will tell you that is not the case. There are few biases which will creep in as we try and make the most rational assessments. The one which is my favorite is “Loss Aversion”. Most of us think differently for gains and losses. We hate losses more than we like gains. Kahnemen has a great example to illustrate. He asks his students; “ I am going to flip a coin, and if is tails , you lose 10 bucks. How much would you have to gain on winning in order for this gamble to be acceptable to you?”. He says most people say 20 bucks!. That is twice as much upside as there is downside. After all the probabilities of gaining or losing are 50%. While this was a fun game, in real life the implications are fairly serious. We would end up buying insurances which either we don’t need or we pay exorbitant amounts to cover small probabilities (some of those who have premium cars would remember buying 3 levels of insurance covers!) OR We would stick to safe investments even if the real returns after tax and inflation are negative and would erode our wealth significantly over time OR we could and would end up selling stocks which have done well.

In my own network I have come across cases where folks have passed on early stage investment opportunities in companies which are highly successful internet companies today. The opportunities were passed on not because the analysis showed a different outcome (perfectly acceptable) but because of perception that all start ups lose money.

While the “why” needs a neuroscientist and possibly an explanation which would be fairly hard to decipher, I would think, we all consciously allocate a part of our capital towards high risk-high growth investments and invest ourselves emotionally and intellectually to find investment opportunities which would protect and grow our wealth as opposed to losing it to inflation and tax.

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