Societies need a healthy tolerance of failure in order to thrive. The process of “creative destruction” means that there is a constant cycle of companies failing and new, better ones succeeding.
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Economic progress depends on entrepreneurs and investors confronting the risk of failure, and using their persistence and optimism to shrug off setbacks and pursue rewards. If companies or investors stop taking risks, then innovation and wealth creation grind to a halt.
This is easy to accept at a macroeconomic level, but most people have a strong fear of failure, driven by cultural biases and their own psychological makeup. Times of economic uncertainty and market volatility exacerbate this fear. Companies react by amassing huge stockpiles of cash, while some investors respond by sitting on the sidelines and refuse to take risks with even a small proportion of their wealth. This sentiment is understandable but cannot last forever. Companies must at some point invest in productive capacity, and investors must also be willing to invest unless they are willing to see inflation erode their capital.
Part of the problem stems from our perceptions of failure. All too often, the experience is seen as an outcome, rather than a step in the process. But by identifying something as a failure, rather than a temporary setback, then we make it more difficult to learn from the experience. Investors who see losses in their portfolios as “failure” are more likely to respond badly, sell low and lock in the loss. Instead, they should accept that losses are temporary and, indeed, see periods of low valuations as a time of opportunity — to be greedy when others are fearful, as Warren Buffett has described it.
In this respect, financial investors can learn a lot from successful entrepreneurs. We have seen in this report that entrepreneurs use their persistence and optimism to create a healthy relationship with failure. Rather than being discouraged from starting another new venture, many entrepreneurs will bounce back quickly from the experience. They regard failure as a chance to refine their approach, draw valuable business lessons and perform better next time.
Not everyone shares this same persistence and optimism. But we can become more aware of how our character and behaviour influence decision-making, and take steps to counter some of the negative effects. Equally, both financial and business investors can put in place measures to help reduce the risk of failure, and learn more quickly from it. This means accepting that failure exists, and being able to experience losses in a way that it is not catastrophic. It means refining our approach to learn lessons from failure, and investing in a way that is resilient to setback.
Not every failure can be averted, but the chances of enduring the experience can be reduced. With the right frame of mind, both entrepreneurs and investors can ensure that they respond appropriately to setbacks and increase their chances of long-term success.