Originally published March 2022.

Today, insurance, social security and modern medicine help us cope when something bad happens. As we manage risk in our day-to-day lives, we can afford to take fewer precautions than our forebears. They faced very different trade-offs. How different were our ancient ancestors’ approaches to risk management? And what lessons would they have for those that manage investment risk?

The premise of Jared Diamond’s book, The World Until Yesterday, is that by exploring how traditional societies live, we gain insight into the lives our ancestors experienced. Diamond shares stories from his trips to the highlands of New Guinea. The isolated lives of such people provide a “window onto the human world as it was until a mere yesterday, measured against the time scale of 6,000,000 years of human evolution”.

He shows that there are many lessons traditional societies can teach us about bringing up children, conflict resolution, diet and attitudes to risk. Here I highlight some lessons our ancient ancestors may provide for today’s investors. Judging by tribal societies, they knew to be highly selective in risk-taking, to learn from others’ experiences to inform their decision-making and to accept the costs of diversification.

Constructive paranoia and highly selective risk-taking

Once, when Diamond found what he thought was the perfect base camp, he was astonished by the New Guinean’s steadfast refusal to sleep there. 

The problem was the giant tree looming over the would-be campsite. The tree was dead and the New Guineans feared it would fall on the camp. 

Diamond thought their fears were “absurdly exaggerated”, but he could not convince the New Guineans to sleep near the tree. He was perplexed by their overreaction – the tree was huge, looked strong and was not rotten. There was not even any wind to worry about. 

However, in time, Diamond became much more understanding of the New Guinean’s attitude. As he spent more time in the forest, he heard trees falling. Also, he heard stories of New Guineans killed by tree falls. So, while the probability of a tree falling on you in your sleep was very low, it was not zero. 

And, given the absence of emergency and medical services, the costs of being struck by a falling tree were high for New Guineans. Even if you escaped death, broken bones would not be set by a surgeon and they would be permanently impaired.

The actions of the traditional society were therefore far more rational than a Westerner might initially assume. Diamond learned that their extreme caution made perfect sense and came to think of it as “constructive paranoia”. Such attitudes were common in traditional societies around the world and are essential to surviving under traditional conditions in the long run.

Importantly, constructive paranoia does not prevent risk-taking. After all, Diamond observes, in traditional lives “you’ll die of thirst within a few days if you don’t take risks in finding water, you’ll starve within a few weeks if you don’t take risks in obtaining food”.  

The risk of falling trees does not deter New Guineans from entering the forest, but it does mean they are highly attentive to the associated dangers. Similarly, the !Kung of the Kalahari desert will take risks to obtain meat. Indeed, they drive groups of lions off animal carcasses. But they take those risks selectively and judiciously. They will not challenge hungry lions and minimise risks by only chasing away lions that have already satisfied their appetite, at least to the extent that they lack the desire to fight for more.

For investors whose first priority is not to lose money, the lessons are clear. If you aim to minimise the risk of a permanent loss of capital, thinking about what can go wrong with an investment from every angle is key. A failure to consider a sufficient range of alternative outcomes is a major source of mistakes. So constructive paranoia should be embraced.

One method to do so is to use premortems: assume you are in the future and the decision you made has failed, then provide plausible reasons for that failure. Research has shown that through ’prospective hindsight’, premortems help people identify a significantly greater number of potential problems than other techniques.

Premortems can feel excessively negative, but the process corrects for the tendency for Western people to be overconfident. It is an aid to being highly selective. 

Like the !Kung in the Kalahari, investors should allow opportunities to pass when the risk assessment is unfavourable. Then, when the time is right, they should act with conviction.

Learning from the database of humanity

Diamond notes that another common characteristic of traditional societies is the high level of talkativeness. Many Westerners have commented on how much of the time traditional people spend talking, often having very detailed, long-lasting conversations on a single theme. “Everything gets discussed: minute details of events, what has changed since yesterday, what might happen next, who did what and why they did it,” says Diamond.

Of course, talking is essential for maintaining and developing social relationships, but Diamond also sees the “constant stream of conversation” as a means of managing risk. He argues that “by talking constantly and acquiring as much information as possible, New Guineans try to make sense of their world and to prepare themselves better to master life’s dangers.” They seek to learn from others, past and present.

Psychologists would describe what members of traditional societies are doing here as seeking the ’outside view’.

Too often we act in silos and think about plans and predictions through what psychologists call the ’inside view’. We consider the specifics of an individual situation, gather related information and then develop a particular scenario for the future. Typically, the inside view is too optimistic and held with excessive conviction.

The outside view is sought by asking w‘hat happened when others were in this position before?’ New Guineans do this through constant dialogue. Investors also need to tap the database of humanity to better inform their decisions, reduce overconfidence and achieve more accurate predictions. 

Diversification: costly but essential

Diamond experienced another bout of bewilderment when he stumbled across a New Guinean friend’s garden far from his village and in the opposite direction to his other gardens. “It seemed so inefficient to commit himself to a waste of travel time, and the garden’s remoteness made it hard to protect from marauding pigs and thieves,” he writes.

The same behaviour is seen among peasant farmers in the Peruvian Andes where scattered plots meant that the average peasant spends three-quarters of the day walking between them. 

Consolidation of plots would boost productivity. A higher average annual output was certainly achievable. But that was not the objective of the peasants. Their goal was to do whatever was necessary to avoid a low harvest that would leave their families starving. 

A study of the Peruvian peasant’s agriculture showed that there was variation in crop yield from field to field and from year to year. And much of that variation was unpredictable. So, the more numerous the locations, the lower the average yield, but also the risk of ever dropping below the starvation yield. Through long experience, the peasants had learned to scatter their land just enough to protect them from the risk of starvation due to variation in food yields.

Diamond himself points to the lessons for investors: “If you depend on your investment earnings to pay current expenses, your strategy should be that of the peasants.” In other words, diversify and accept the costs of doing so. Lower time-average returns is the trade-off for consistently delivering returns necessary to meet obligations. Investors delivering cash-flow or liability-matching solutions need to be mindful of the peasant’s scattered plots.