Behaviouronomics: Placebo Effect

Just about everyone is familiar with the placebo effect — a beneficial effect, produced by a placebo drug or treatment, that cannot be attributed to the placebo’s properties, and must therefore be due to the patient’s belief in that treatment.

However, most people have only a cursory understanding of this behavioural quirk. Until the last few years, even I had a very shallow knowledge about Placebo Effect. As I read more about various cognitive biases that plague the human brain, I realized that the Placebo Effect’s implications cast their net much wider than I would have imagined.

Sometimes during my scheduled daydreaming sessions, I imagine having conversations with people from different fields. One such imaginary discussion involved a medical doctor who has a clinic near my home.

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“So doc! Tell me something ironical about your profession?”, I asked him thinking that a question like that could lead the conversation to an interesting direction.

“The biggest irony of being a physician is that many people don’t really need doctor’s help. Many a time, my prescription is effective because people believe in them. Their belief in my treatment is what cures them. You see your doctor and you feel better.”

He continued, “Sometimes just the fact that a doctor or nurse is paying attention to us and reassuring us not only makes us feel better but also triggers our internal healing processes. In many cases, they would benefit just by popping a sugar pill.”

He was talking about the classic case of the Placebo Effect.

“So if most of these people don’t need medical intervention, why do you always end up prescribing something or the other?”, I asked him, “I think it’s not a secret that many of these drugs do more harm than good in the long run.”

“That’s the second and more unfortunate irony of my profession, Anshul”, he sighed, “If I don’t prescribe any medicine to my patients, they feel I haven’t done anything to help them. Why would they pay a hefty fee for doing nothing? And as I explained, prescribing these medicines have a psychological effect also. Just because they are popping a pill makes them believe that they are getting better.”

It’s not just true about medicines. Even in the field of medical surgeries, Placebo Effect is more prevalent than you’d have ever guessed.

Dr Ian Harris, a Professor of Orthopaedic Surgery at the University of New South Wales in Australia and a practicing orthopedic surgeon specializing in trauma surgery, describes surgery as the ultimate placebo.

Majority of surgeries that Dr Ian Harris studied are not more effective than placebos. This is shocking because even when we have no proof that they work, many of these surgeries are happening even today.

I found about Dr Harris from Paras Chopra’s podcast. Dr Harris explains –

Examples of such ineffective surgeries include back pain surgeries and knee pain surgeries. For such surgeries, randomized control trials have found that if you make an incision in the knee but don’t do anything, it’s as effective as actually conducting the knee surgery.

So Why do patients get better if the surgery doesn’t work? It’s because many diseases or pain have a natural progression, and we generally seek surgical/medicinal intervention when we’re in the worst condition. If the condition becomes better after that, we attribute improvement to the intervention rather than thinking it could have happened anyway (due to the natural course of the condition).

Dr Ian Harris said, the unsaid attitude could be stated like: “you have to operate on patients quickly before they get better.”

As you shake your head in disbelief, remember that bloodletting was a very popular and accepted medical practice for thousands of years until mid 19th century. Even after randomized trials showed that it hurt the patient, bloodletting continued to be the most common surgical procedure. The reason was apparent – if your salary depends on not believing something, you won’t believe it. Bloodletting eventually died a slow death as its practitioners started dying.

Placebo effect is both powerful and dangerous. Powerful because of its psychological aspect and dangerous because of the way incentives often create a hurdle for those who should take the initiative to challenge the placebo practices.

So what’s the relevance of Placebo Effect in investing?

Joe Wiggins, in his blog, makes an interesting observation. He writes

We can reframe this [Placebo Effect] slightly and create an ‘investment placebo’:

A beneficial effect felt by an investor by a certain investment activity, which is unlikely to be attributed to the properties of the action itself, and must therefore be due the investor’s belief in that activity.

What kind of activities might be captured by the above definition? Some of these – 

• Short-term trading/market timing.
• Trading on macro-economic news.
• Performance chasing in active mutual funds.

In short, in investing any activity that produces a good outcome, often it’s not the result of your activity but something else (luck, broader market movements, etc.) unless you have a way to tie back the thread of causality — the medical equivalent of randomized control trials.

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