4D And Insurance: What Are The Odds?

Disclaimer: Not endorsing any form of betting/gambling here btw.

Do you know what are the odds of you striking the top prize for 4D in Singapore?

1 in 10,000 (as the helpful Seedly folks have calculated here). If you think this is hard, the odds of the average American winning the Mega Millions lottery is 1 in 320 million for the top prize of a whopping USD 970 million.

Talk about instant huat and small odds.

Some people may have won a prize or another but the top 4D prize.. well, you're better off investing that money. But despite the rational understanding of probability, 52% of Singaporeans have dabbled in 4D, one way or another. Before we explain this phenomenon, let's look at another example.

Most of us have likely bought a form of travel insurance before our globe-trotting journeys but do you know that the probability of someone dying in an airplane is 1 in 188,364? How many of us would take a plane 1,883 times, not to mention 188,364? Yet, travel insurance is something we will gladly buy without batting an eyelid.

The odds of winning and losing here are extremely low but yet, 4D and insurance is something many will pay money for. Why is that so?

Enter In Prospect Theory

Humans are complex but they aren't unpredictable despite the seemingly financially irrational decisions (defined by probability, NOT importance) we make. Nobel prize winner Daniel Kahneman and Amos Tversky explained these two phenomenon with Prospect Theory:

Humans have a tendency to overexaggerate the probabilities of winning or losing.

This leads them to take chances with winning, and not take any chances when the probability of losing is looming despite the low odds.

Insurance isn't just for the kiasi and 4D isnt just for people with wishful thinking. It actually explains the psychological make up of our being.

The interesting aspect of Prospect Theory is that our response to wins and losses are actually assymetrical. Let's contrast two situations: Imagine you found a dollar coin. You'll likely be happy but contrast the reaction if you lost a dollar coin. The pain of losing will be felt more acutely compared to the joy of winning.

Which explains the next point: Humans are more risk-averse than they are risk-seeking in the face of losses.

Risk aversion explains insurance-buying behaviour. The "what if something happens to me" nagging thought isn't tied to a timid personality but it's something we're wired for.

There are reasons for our risk aversion to losses and risk-taking tendencies for huge wins. Both of them might be a part of our way of adapting to danger and seeking opportunities because our ancestors had to deal with external threats and traverse out of the unknown to hunt for food. While these tendencies play a huge part in the survival of our ancestors, they have a huge role in our financial planning journey.

1) Understand Yourself Better

The first thing we have to understand is that often, humans (meaning you) make emotionally-driven financial decisions. The fear of losing, the desire for big wins, these are all emotions that often guide our financial decisions. That's not a bad thing, but when you understand your own risk tolerance and psychological make-up, it helps you to make better financial choices.

Some people may have a higher risk aversion and some may be more risk-taking but the key is to know at which point of your life is the risk you're taking too little or too much risk.

2) Respect The Risk Aversion-Risk Taking Equilibrium

While it may seem like an inner tension, there should be an equilibrium with our risk aversion-risk taking tendencies. Equilibrium here suggests that there shouldnt be an excess or lack in both tendencies. Both have to be regulated in tandem in our financial decisions.

For example, to seek out ways to invest without a safety net of insurance will be foolish for the layperson in the event of a financial crisis. Likewise, to merely find ways to protect oneself financially without taking on the risk of gain is disadvantageous. Sometimes, the safest place is the most dangerous place.

3) All For A Peace Of Mind

Insurance and 4D are examples here and I'll not suggest pegging the importance 4D over insurance. But in the end, know that the risk you're taking today is, ironically for a peace of mind. You will never have the peace of mind if you take too much risk at your life stage, such as investing 100% of your portfolio in crypto and not have any protection strategies in place. Neither will you have the peace of mind if you do not take any risk to grow your wealth.

Ultimately, risk aversion and risk-taking is for a peace of mind and for the layperson, all of their financial dreams and aspirations should lead to that.

Writer first, then advisor. Huge believer in InsurTech to enable customers to receive reformed financial advice.