The Cherry Coke Effect?

Hunger Games

If you want a favorable decision from a judge pray that you get a hearing early in the day or straight after lunch.  In similar fashion you shouldn’t be making investment decisions on an empty stomach.  In the parlance, such arbiters of justice and seekers after profit are suffering from ego depletion; although we might perhaps just say that they’re hungry.

Anyway, ego depletion seems to have a real effect on our ability to make important decisions: we’re more likely to be decoyed, to procrastinate and to compromise over our decisions when we’re low in energy.  So this explains why Warren Buffett is such a good investor; it must be down to his addiction to Cherry Coke. Surely?

Read Full Post >>

Sapir-Whorf Economics: Your Language Predicts Your Future

A Resumption

Apologies for the recent temporary hiatus, been rather busy with that strange thing called real life.  More regular updates from now on but, for a while, they'll be more limited than in the past due to the need to fulfil a book contract.  Still, it’ll be something to add to the Christmas wishlist.

So … let’s look at something really odd, and why, if you’re a useless procrastinator  you should really want to learn German.  It seems that cultural stereotyping may not be quite so irrational as we may have thought …

Read Full Post >>

Unrealistic Optimism and the Impoverished Investor

Hope is the thing with feathers that perches in my soul – Emily Dickinson

Eternal Optimists

Humanity is unrelentingly optimistic in the face of contradictory evidence.  Our ability to demonstrate unrealistic optimism bridges cultures, races, genders and societies.  We simply will not face up to the nasty reality of the real world, whatever that is.

This bias is so pervasive that it’s highly unlikely to be a social adaptation to culture and is probably an evolutionary trait, hard-wired into our brains.  No matter how it arises, it’s going to induce investors to take a positive view of the world: a view which cuts right across behavioral investing rule number one.

Read Full Post >>

Retirees, Procrastinate At Your Peril

Fun or Future Famine

Given a choice between doing something light-hearted and fun which brings immediate gratification or something boring and difficult that won’t pay off for decades – if ever – most of us wouldn’t find it very difficult to make a choice. In fact we’re probably designed to operate this way, since the probability of surviving long enough to enjoy our future wasn’t very great for most of human history.

Now, however, things are different. In the developed world most of us are going to live long past our sell-by dates. Which means our in-built tendency to prevaricate over the tricky, boring and very long-term problem of preparing for retirement is an issue that most of us can’t afford to put off a day longer. If we’re to avoid eking out our dwindling days in destitution we need to stop procrastinating, pronto.

Hyperbolic Discounting

Procrastination is the technical term for the preference of pleasure today over pleasure tomorrow. It’s been the subject of considerable research because the failure of tomorrow’s pensioners to plan for their old-age is a major concern for governments. They’d rather not have to deal at all with old people who don’t pay any taxes and who are a burden on healthcare services, but when they haven’t got any savings they’re worse than a nuisance as they tend to moan a lot and generally vote the wrong way.

One of the odder impacts of procrastination is the effect of time as captured by something called hyperbolic discounting utility. Generally people will take $100 today over $110 tomorrow but would rather have $110 in twenty one days over $100 in twenty. Of course, when the days count down and day 20 becomes today they reverse their preferences. This is profoundly irrational because over such short periods the risk of not being paid is minimal.

Paying Through The Nose

Our desire for short-term gratification and our inability to properly calculate the cost of money allows companies to make heaps of profits out of us. Pretty well anything that enables us to get what we want today without paying for it until tomorrow is enough to get us hooked. So offers of instant credit by stores gets people buying on the never-never like there’s no tomorrow. Only there is, and when it comes we pay through the nose.

Of course, the counter argument is that people should show more self-restraint and that our consumer oriented economy is at fault. The evidence, sadly, is that self-restraint is the exception, not the norm, and people like consuming: it stimulates the limbic centres of the brain and makes them feel happy. Extreme shopaholics have to be treated by drugs targeting these areas, such is the addiction issue.

Hedonism Versus Inertia

Stores aren’t the only beneficiaries of our short-term hedonistic ways. Credit card companies are well known for offering low or zero teaser interest rates to get people to switch, only to rack up the fees later on. The huge impact of the short-term is shown again by research which demonstrates that people will go for the lowest possible initial rate even if offered a better deal with a slightly higher starting rate.

The credit card transfer effect is, in fact, a war between two competing tendencies – short-term pleasure seeking and basic inertia. The rates have to be so good because otherwise we just can’t be bothered to change our ways. Banks habitually take advantage of this by offering zero interest on checking accounts and higher interest savings accounts. No matter how easy it is to transfer funds we generally don’t bother doing so, presumably because we’re out shopping and filling in credit card applications.

The list goes on: preferential insurance rates for new customers, payday loans, mortgage protection policies and extended warranties for instance. The latter two products capitalise on another psychological trait, by the way: the tendency to not worry about small add-on costs when you’ve just made a large purchase. That’s why a salesperson will always sell you a suit first and the accessories afterwards – when compared to the large upfront cost of the expensive suit it’s relatively easy to sell other items afterwards because we anchor on the big number. Suits you, sir.

Retirement Planning Isn’t Pleasant

However, the problem of procrastination goes way beyond the simple issue of instant gratification versus delayed pleasure. Whenever we decide to do something we implicitly decide not to do other things. Even more, we need to decide which tasks to devote time to and which to simply skim over. More difficult and less pleasurable tasks – such as planning how to save money for retirement – are likely to find themselves at the bottom of the list. If they get done at all procrastination will tend to ensure that they’re done inadequately: so retirement planning defaults to what someone who knows a friend who’s consulted an advisor is doing.

Anyway, it’s doubtful if most people can figure out how much they need to retire on. Take Harry Markowitz, the inventor of modern portfolio theory. Did he analyse the co-variances of the various asset classes available to him to figure out an efficient frontier in order to design a portfolio optimised to give him the best return for the lowest risk?

Did he heck.

He did what most people do and split up his contributions equally between the available asset classes. However, there’s a lesson here as well. Better a roughly right decision made quickly than a perfect solution that takes a decade to implement. The time to act is now. Always.

Dumb, Dumber and Poor

As ever in finance financial biases are most damaging to those people with less understanding of the problem area. Procrastination is no different. So reasonably aware and switched on investors are less likely to delay sorting out their finances. As O’Donaghue and Rabin have shown, even relatively low levels of problems with self-control can cause naive investors to avoid the issue completely. It falls in the class of “too hard” so they never get round to dealing with it.

But it gets worse (of course it does, this is the Psy-Fi Blog). Understandably people are more likely to procrastinate over important issues than minor ones. So, for instance, someone may decide to sort out their retirement savings issue but then be unable to complete the task because they’re presented with too many options. Fear of getting things wrong may mean that they end up doing nothing.

The researchers argue that three factors interact to determine whether or not procrastination takes place – self control or lack thereof, domain knowledge or a similar lack thereof and the range of possible options. Even people with good knowledge and exemplary self control may end up dithering if presented with too large a range of options. And, to cap the issue, the more important an issue is, the more procrastination is likely. So investing $100,000 is likely to prove harder than investing $10,000. Although presumably spending it wouldn’t provoke the same level of cognitive dissonance.

Paralysis By Analysis

The odd, but inevitable conclusion, from this research is that when figuring out what to do about the tricky business of retirement investing people may never get around to doing it because it’s too important. It’s hard to know what’s worse – a mass of pleasure seeking, live for the moment hedonists ignoring their retirement problems because of lack of self-control or the responsible and thoughtful folks who are paralysed by analysis.

The answer to this appears to be one that sits uncomfortably with democratic, free market ideals – to use our behavioural biases to coerce people into doing what’s best for themselves. Whether you agree with it or not the evidence is clear: if we don’t help people help themselves then we’re looking at a grim future for millions of dumpster diving pensioners. The alternative may be waking up to find a granny in your garbage.


Related Articles: It’s Not Different This Time, The End of the Age of Retirement, Don’t Lose Money in the Stupid Corner