Blame evolution – it makes monkeys out of us all when it comes to financial decision making

When we humans make crap financial decisions – from the Global Financial Crisis through to holding on to bum shares too long – is it because we are greedy, silly, don’t have all the facts, have put Alan Greenspan in charge?

Or could it be that we have been hardwired by evolution to mess up?

An interesting and disturbing study shows it maybe the latter. When it comes to figuring out risk/reward situations, we are lumped with 35 million years of inept strategizing.

Laurie Santos, who runs Yale University’s Comparative Cognition Laboratory, studies primate psychology and monkeynomics, looking for the roots of human irrationality by watching the way our primate relatives make decisions.

You may not be surprised to hear that we share many of our irrationalities with monkeys.

But according to Santos this also applies to financial decision making, something we think we’d be better at than monkeys.

What follows is an edited version of a 20-minute Santos speech on TED.com.

She says: Humans are smart, but we can be incredibly dumb in some aspects of our decision making.

In the last few years we have seen unprecedented examples of ineptitude:
• Environmental disasters
• Financial market troubles.

We like to think that the mistakes we make are the result of bad apples.

It turns out that what social scientists are actually learning is that when most of us are put in specific contexts we will make very specific predictable mistakes.

How come? Why can’t we figure this out?

There are two possibilities:
1. It’s not really our fault. We have created environments that are too complicated for us to understand, for example financial markets. The easy solution to this is to figure out what we can’t deal with and get rid of it.
2. But maybe it’s not our environment that is messed up. Maybe it is us that is designed badly. People tend to make the same errors over and over again. It feels like we are built to make certain errors in certain ways.

If it is us that is messed up, it is not clear how we can go about dealing with this situation.

How can you tell if it is possibility one or two?

We looked at monkeys. They are smart and cute and lack all the stuff that is messing us up.

And they broke off from the human branch of primates about 35 million years ago.

If you put a monkey in the same situation as humans do they make the same mistakes as us?

We started our work at the start of the Global Financial Crisis. We wanted to see if monkeys do the same dumb things we do.

But monkeys don’t use money so we taught them how to use money (tokens) to buy food.

We asked if monkeys would spontaneously – as if this was really their currency –pay attention to price and create a monkey market place?

The interesting stuff was when we collaborated with economists.

The monkey findings basically matched, not just qualitatively but quantitatively, what we saw humans doing in a real market.

The question was do monkeys mess up in the same way we do?

Anecdotally we saw things that showed they might: we never saw any evidence of saving and there was evidence of larceny.

We wanted to speed things up a bit so we said, let’s give monkeys the same kinds of problems that humans tend to get wrong.

In a human risk test, if you gave people $1000 each, most people would play it safe if asked them to chose between a toss of the coin – heads you get a thousand dollar more; tails you lose the lot – and just getting another $500.

Most people say, why should I be risky when I can get $1500 for sure, I’ll go with that.

So what?

The so what comes when we think about the same problem set up a little bit differently. You have to decide how you are going to lose money.

I’ll give you $2000 to put in your pocket.

How about a choice between a risky loss – heads you keep the lot, tails you get nothing.

Or play it safe and hand over $1500 and keep $500.

When presented with these options, people don’t chose to play it safe.

People’s appreciation risk varies according to where they started.

What’s going on – we appear to have two biases at a psychological level:
• One is that we have a really hard time thinking in absolute terms
• Secondly we find it very easy to think in relative terms.

This affects our thinking about whether options are good or not.

Loss aversion – we really hate it when we have to lose out on some money. We will switch our preferences to avoid this.

Subjects get risky because they want the small shot that there won’t be any loss.

That means when we are in a loss mindset, we can be more risky.

This plays out in lots of ways with humans:
• Holding on to shares that are losing value
• Why people hold on to their houses in a falling housing market because they do not want to sell at a loss.

Do monkeys show the same biases?

Like humans do they choose to play it safe or go risky for the possibility of getting a big bonus?

Qualitatively and quantitatively they choose the same as humans.

This is crazy – it shows the monkey are evaluating situations in relative terms and treating losses differently than they treat gains.

What does it mean. It means monkeys are like us.

The original question was: where do these kinds of human of errors come from.

What we have learned is that biases might be a deeper part of us than thought. In fact they may be due to the very nature of our evolutionary history.

It means that these duncey strategies might be 35 million years old.

We know that old strategies like this can be really hard to overcome.

When your shares fall, or your house price plummets, you are not going to be able to see that in anything but old evolutionary terms.

That means crises that lead to investors to do badly are going to be really hard to overcome.

The good news – humans are not only smart, they are inspirationally smart. We are so good at overcoming our biological limitations.

But we have to recognise that we have these limitations, accept them and figure them out and then we might be able to achieve our own human potential and to be the noble species we all hope to be.

[Photo credit - Evil Death Monkey Possessed by Spirit by Nekominn/Flickr]