Behaviouronomics

Imagine you are in Las Vegas with your friend. While walking on the Las Vegas Boulevard you find a US$ 10 bill sticking out from the side of the pavement, as if it’s telling you “Pick me!” You pick up the note and feel happy about your moderately good fortune.

“Wait a minute! Is that a sign from the universe?” you whisper to yourself. Perhaps Lady Fortuna is nudging you to try out your luck using this US$ 10 totem. After all it’s Las Vegas…the gambler’s paradise.

Your friend however is tired and heads back to the hotel. But you just can’t ignore the sign from above. Taking this as an omen, you enter the first casino and head straight to the roulette table. You want to bet on your lucky number i.e., 7. Sure enough, the roulette ball hits 7 and 35-1 bet wins you US$ 350. You let your winnings ride and the ball lands on 7 again, paying you US$ 12,250. And so it goes. Within an hour you are a multimillionaire with US$ 50 million in your kitty.

Feeling like Daniel Ocean from Ocean’s Eleven, you intend to bring the house down with your raging streak of luck. Being just one step away from becoming a billionaire you bet all your money on number 7 one last time – only to lose it all this time. Broke, dejected and little flabbergasted you walk down several miles to join your friend in the hotel room.

“Where were you man?” asks your friend as you enter the room.

“Playing roulette.” You’re still feeling a little shaken.

“How did you do?”

You cut the story short and tell him, “Not bad. I lost ten dollars.”

My question to you is – “Did you really just lose $10?”

If your answer is yes, then perhaps you are unaware of the behavioural bias called Mental Accounting.
[Read more…] about Behaviouronomics: Mental Accounting

Read about the feeling of psychological discomfort that’s produced by the combined presence of two thoughts that do not follow from one another, and how to overcome such situations.

I am sure many of you have heard the famous Aesop’s fable about the fox and the grapes. If not, here’s the story. A fox sees some high-hanging grapes and wishes to eat them. When it is unable to think of a way to reach them, it decides that the grapes are probably not worth eating, with the justification the grapes probably are not ripe or that they are sour (hence the common phrase ‘sour grapes’).

Every time I hear this story, I laugh at the delusional fox. However, I rarely imagine that a similar fox is inside me also. The fable is a classic illustration of what psychologists call Cognitive Dissonance.

Let’s see what the formal definition of Cognitive Dissonance says –

The feeling of psychological discomfort produced by the combined presence of two thoughts that do not follow from one another. The greater the discomfort, the greater the desire to reduce the dissonance of the two cognitive elements. Dissonance theory suggests that if individuals act in ways that contradict their beliefs, then they typically will change their beliefs to align with their actions.

This is a behavioural bias which evolution has wired into the human brain. In the ancient hunter-gatherer environment, if a man saw something vague it was important for him to get rid of the doubt (whether it was a harmless rabbit or a dangerous panther) immediately. A quick decision was essential for survival. This quality gave an evolutionary advantage to human beings.

But evolution is a slow process and it hasn’t caught up with the rapid changes in our environment. In the modern world, there are hardly any such life threatening situations, but the brain’s hard wiring hasn’t changed much in last few thousand years. So we continue to take decisions under the influence of these psychological reflexes.

One of the best examples of cognitive dissonance that you can see around is people who continue to smoke even after being aware of the harmful effects of smoking. How do they deal with this conflict between what they know and how they act?
[Read more…] about Behaviouronomics: Cognitive Dissonance

Always being in the thick of action can be dangerous to your long term investment returns. The habit is difficult to overcome, but you must definitely make a start. Read more to find out.

Have you noticed that there are some people who are so restless that they find it impossible to sit at one place quietly? They have very short attention span and can’t stay with one activity for long. In medical science this abnormality is known as ADHD (Attention Deficit Hyperactivity Disorder).

Now before you brush aside ADHD as something which isn’t relevant to you, allow me to hold your attention for one more second. Here is an interesting fact – Evolution has installed the seeds of ADHD in every human brain.

Some people have very severe symptoms of ADHD and they may need medical treatment. But for the rest of us this disorder manifests very subtly in our day to day decision making.

Famous scientist Blaise Pascal figured something very deep when he said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.”

In an attempt to be efficient and productive, we force ourselves to always stay busy with some task or other. But sometimes too much activity is counterproductive. In behavioural finance, it’s called Do-Something Bias.

A wise man once said, “There is no bigger waste of time than doing something efficiently which shouldn’t be done at the first place.”

Do-something bias is not only wasteful but can harm you in the long term.
[Read more…] about Behaviouronomics: Do Something Bias

One peculiar but common way our brain works is that we often remember what’s easily available to us, and see what’s easily visible.

So, we conclude that the stock trader who is rich must know what he is doing. In the same way, an investor who uses leverage to increase his bets and in the process magnifies his returns is also considered a role model.

In business, a CEO who borrows a lot of money to make acquisitions and in process turns his business bigger in quick time, also seem to be doing the right things (at least when times are euphoric).

[Read more…] about Behaviouronomics: Alternate History