Wednesday, February 20, 2008

Fear trumps greed

Conventional wisdom has it that in our capitalist system, the best way to induce any particular event into happening is to provide an economic incentive for it's occurrence. In layman's terms, this means that no matter what we want to achieve or obtain (A nicer house? Improved customer service?) the most efficient way of making that happen is to offer cold, hard cash after the fact as a reward.

In macroeconomic terms, governments do things like this all the time -- dangle tax cuts for a particular industry that they're trying to stimulate investment in. And companies do the same, by, say, putting certain items on sale so we're more inclined to buy them. Even in our own quotidian lives, we use positive reinforcement to induce ourselves into certain actions -- we reward ourselves for sticking to a diet, or allow ourselves a treat after accomplishing some sort of savings target, to name but two examples.

It's not necessarily an irrational view to take. But the more I think about it, the more I'm convinced that taking the opposite tack might work just as well: instead of rewarding success, punishing failure can be a lot more effective.

Take my cousin. He's come up with a novel way of raising money for a charity he supports. He's planning on running the London Marathon in April, and rather take than the conventional strategy of soliciting for donations, he's put his money where his mouth is and basically betting with his friends on what his finishing time will be. He's never run a marathon, and he's shooting for a time of 3 hours, 30 minutes -- quite a good time, I'm told. He's trying to cull together a donation 1000 pounds (about $1970 Canadian) for a cancer hospice. If he hits his target time, his list of donors will have to come up with the 1000 quid. But if he goes over his target time, he'll donate the 1000 pounds out of his own pocket.

I think this is a novel approach, and one I'm happy to support as part of my own ongoing charity plans. The added bonus that will probably come out of this is that if he doesn't hit his ambitious target, he'll put up 1000 pounds of his own money, and his friends will pitch in an additional 1000 to support a good cause, so everybody ends up happy. So finish that cheeseburger and have that second beer, I say. :)

But to me, the really interesting thing about all of this is that rather than take the conventional view of setting a goal and rewarding himself for achieving it, my apparently overly-rationally-minded cousin is more motivated by actually losing money through failure than by the prospect of being rewarded for success.

I think deep down, a lot of us are like this even if we fail to realize it. Why else do we, as investors for example, have a tendency to sell our winners too quickly after we've pocketed a nice gain, but we'll painfully watch as our losers slide further and further into the red because we're unwilling to accept defeat? And why is it that the investing stories we obsess over for years aren't the times we pocketed a 60% gain in three months on some flash-in-the-pan tech start up, but rather, the thousands we lost because we tried to catch a falling knife named Nortel?

Because we hate failure a lot more than we like success.

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