Category: Business

Yesterday, I wrote about why most people are more afraid of terrorist bombings than car accidents. It’s because of how the brain (and more specifically, the amygdala and the neocortex) deals with risk.

That got me thinking. How does this effect investors and entrepreneurs, both of whom have to deal with risk in order to be successful?

Investors who can control their emotional responses are most successful, according to John Buckingham’s article in Forbes Magazine, “Warren Buffett: Functional Psychopath?” The article includes the following statement from Warren Buffet’s preface in Benjamin Graham’s The Intelligent Investor:

To invest successfully does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework.

“The ability to keep emotions from corroding the framework.” Now there’s an argument for the neocortex if I ever heard one. A paper co-authored by faculty at Stanford University, Carnegie Mellon University and the University of Iowa even showed that “people with [emotionally impaired] brain damage make better financial decisions than normal people” because they’re able to rationally weigh the facts and take calculated risks.

Same goes for entrepreneurs. Taking risks is a major part of entrepreneurship. Rather, taking risks for potential rewards, as Paul Graham writes in his essay, “Inequality and Risk“:

Startups are intrinsically risky. … It seems only about 1 in 10 startups succeeds.

The fact that you’re investing time doesn’t change the relationship between risk and reward. If you’re going to invest your time in something with a small chance of succeeding, you’ll only do it if there is a proportionately large payoff.

Since risk and reward are equivalent, decreasing potential rewards automatically decreases people’s appetite for risk. Startups are intrinsically risky. Without the prospect of rewards proportionate to the risk, founders will not invest their time in a startup.

So if our brains can’t effectively calculate risk, unless we’re brain damaged, how can we expect to invest wisely or be an entrepreneur?

The answer is to raise your emotional intelligence (thereby, presumably, strengthening your neocortex). This may not be possible though, according to John Mayer, one of the authors of the Mayer-Salovey-Caruso Emotional Intelligence Test (MSCEIT), a commercial product that measures emotional intelligence (which is just one out of many other products out there). When asked point-blank, “Can emotional knowledge be improved?“, he answers:

No well-conducted, published studies have been reported in regard to raising emotional intelligence to date. Up to now, however, with a few exceptions, emotional intelligence has behaved much like other intelligences, and it seems very unlikely that it could be easily raised. Still, as very little research exists on the topic, it remains an open question.

That’s not a definite No, however. Goleman suggests understanding your emotions first as a step towards better managing them. He also offers this high-level guidance:

1. Know your emotions – People who know their feelings are better pilots of their lives.
2. Manage your emotions – People who are effective in managing their emotions can cope better with life’s adversities and can bounce back faster than those who are poor in managing their feelings.
3. Motivate yourself – People without emotional intelligence lack self-restraint and would just do whatever their impulses suggest. Emotional self-control, delaying gratification and stifling impulsiveness underlies accomplishment of every sort.
4. Recognize emotions in others – Emotional self-awareness is the first step to empathic sensitivity. In other words, if we are in touch with our own feelings, then we can empathise with others and sense their needs.
5. Handle relationships – The art of relating to others includes the skill in managing emotions in others. For example, the ability to calm distressing emotions in others can help resolve many conflicts.

These guidelines sort of fit the studies done on subjective well-being too, which have shown that people who are happier tend to be more successful investors (and entrepreneurs too, perhaps). A higher level of emotional intelligence would seem to lead to a higher level of happiness.

So does a greater control over one’s emotions lead to a greater control over one’s response to risk? All of these reports seem to indicate so, though much of this science is still new. In my opinion, raising one’s emotional intelligence (if possible) is a good thing for any investor or entrepreneur, even if it doesn’t effect one’s perception of risk.