A Dozen Lessons About Investing and Money From Dan Ariely - 25iq

25.09.
2023, 20:56 A Dozen Lessons about Investing and Money from Dan Ariely – 25iq
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A Dozen Lessons about Investing and Money from Dan

Ariely
September 1, 2017
Dan is a Professor of Psychology and Behavioral Economics at Duke University and

the founder of the Center for Advanced Hindsight. His research and work is about how
people actually act in the marketplace, as opposed to how they should or would
perform if they were completely rational. His books include Predictably Irrational, The
Upside of Irrationality, The Honest Truth about Dishonesty, and Payoff. His next book is
entitled: Dollars and Sense: How We Misthink Money and How to Spend Smarter and
will arrive in stores in November.
1. “We’re such good storytellers that we come up with stories that portray us in
good ways, so we don’t always even see our own mistakes. And then on top of
that, it’s about our social standing, and admitting failure also admits that we might
be wrong in the future.” “We all want explanations for why we behave as we do
and for the ways the world around us functions. Even when our feeble
explanations have little to do with reality. We’re storytelling creatures by nature,
and we tell ourselves story after story until we come up with an explanation that
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25.09.2023, 20:56 A Dozen Lessons about Investing and Money from Dan Ariely – 25iq
we like and that sounds reasonable enough to believe. And when the story
portrays us in a more glowing and positive light, so much the better.”
A New York Times reviewer of Airely’s book Predictably Irrational describes one of his
foundational conclusions as follows: “We aren’t cool calculators of self-interest who sometimes
go crazy; we’re crazies who are, under special circumstances, sometimes rational.” The
situations in which human are not rational are sufficiently predictable that systems can be
created to achieve Airely’s goal of: “gaining a better understanding of our ability to make
decisions, and identifying the places where we fall short, in order to better design products,
interventions and policies.” In short, by understanding biases that can impact human behavior
we can become better choice “architects.” For example, by creating the right structure we can
make decisions more or less likely to happen depending on the results we want to achieve.
Here is a grim but powerful example of how making something harder changes behavior:
Prior to the 1950s, domestic gas in the United Kingdom was derived from coal and
contained about 10-20% carbon monoxide (CO). Poisoning by gas inhalation was the
leading means of suicide in the UK. In 1958, natural gas, virtually free of carbon monoxide,
was introduced into the UK. By 1971, 69% of gas used was natural gas. Over time, as the
carbon monoxide in gas decreased, suicides also decreased. Suicides by carbon
monoxide decreased dramatically, while suicides by other methods increased a small
amount, resulting in a net decrease in overall suicides, particularly among females.
If this change can reduce the level of suicide imagine how much it can increase the willingness
of people to sign up for a savings programs or a 401(k). Decision-making frictions can have
positive or negative impact depending on the desired outcome. people can be nudged just like
frames.
The Exciting World Of Frame Nudging! (The Simpsons)
2. We look at the most recent evidence, take it too seriously, and expect that things
will continue in that way.” “If you think about the creation of asset bubbles, that’s
always what happens. Things go up and up and up, and we start thinking it has to
always go up.” “It’s very hard for us to deal with lots and lots of information. Of
course, today we’re getting lots and lots of information, so what do we do when
we get too much information? We simplify. We use heuristics. We rely on only part
of the information. On the most salient information. And that, of course, means
that the most salient information is probably the information everybody else
knows, as well; so we become less independent in our opinions from other
investors. If everybody is in information overload, and we all do simplifications,
then what happens is that we follow the simplest source of information, which is
probably common to everybody.” Recency bias and herding.
A human brain has many taxing decisions to make all day long. It naturally look for shortcuts
and was to reduce cognitive load. It has a preference for readily accessible information like
recent memory, over the hard work of thinking and analysis. If you have seen something
recently is is easier to remember and take into account. People who have seen a stock or a
market index go up recently are more likely o think it will go up more. People who have seen a
picture of some who has won the lottery and more likely to believe that they will win the lottery.
Nothing sells more lottery tickets than pictures in the news showing ordinary person holding a
cardboard check from the lottery board. The tendency of people to follow the crowd is
illustrated by a story that Warren Buffett likes to tell about a deceased oil prospector who is told
by St Peter that Heaven’s allocation for his profession is full. The speculator yells “Oil
discovered in Hell.” A stampede of people streams out of Heaven toward Hell. St Peter informs
the prospector that he is welcome pass through and enter heaven. “No thanks,” said the
prospector. “I’m going to check out that oil discovered in Hell rumor. Maybe there is some truth
in it after all.”
Herd Behaviour (explained in a minute) - Behavioural Finance
3. “Money is really about opportunity cost. Every time you buy coffee, the money
comes from something else. What is this something else? We don’t envision it.
With money, the trade offs are really unclear.” “Every time we buy something, it’s
about what we are not going to be able to do in the future.” “The problem with
opportunity cost is that opportunity cost is divided among many, many things.”
Opportunity cost.
Charlie Munger is a strong believer in making decisions based on opportunity cost.
“In the real world, you uncover an opportunity, and then you compare other opportunities
with that. And you only invest in the most attractive opportunities. That’s your opportunity
cost.” “We’re guessing at our future opportunity cost. Warren is guessing that he’ll have the
opportunity to put capital out at high rates of return, so he’s not willing to put it out at less
than 10% now. But if we knew interest rates would stay at 1%, we’d change. Our hurdles
reflect our estimate of future opportunity costs.” “Warren is scanning the world trying to get
his opportunity cost as high as he can so that his individual decisions are better.”
When some asked you to buy something your decisions should not be limited to that question.
The better question to ask is: Of all of the things I can buy or otherwise do with this money, is
this what I want to do? The question should not be: should I buy stock X. Instead, out of all the
stocks or other investments in the world other should I buy X?
4. “When things like complex financial instruments are difficult to evaluate, it’s
easier for us to rationalize unethical behavior and the effects of conflicts of
interest become larger. Finally, when other people around us behave similarly,
conflicts of interest rule even more.” “The overall market for annuities is bad
because it is very obscure. It is hard to price. And annuity companies can use lots
of hidden fees and costs. If you think about it, it’s a market where most people
who sell annuities get their commissions upfront which tells you that it’s probably
(a) a hard thing to sell, but (b) that the companies need to incentivize sales people
to sell them, which I think suggests (c) that there has to be something quirky
about the whole system.” Incentive caused bias.
Charlie Munger says: “Where you have complexity, by nature you can have fraud and mistakes.
You’ll have more of that than in a company that shovels sand from a river and sells it.” As an
example, Munger says the U.S. healthcare system is “ridiculous” in its complexity. “The whole
system is cockamamie,” he has said. There is he value in keeping an investment plan and
investment decisions simple. You will make fewer mistakes and be a happier person. Research
Affiliates makes three key points about this bias:
A preference for complexity is almost hardwired into investors, their agents, and asset
managers because the intuition is that a complicated investment landscape requires a
complex solution; a complex strategy also supports a higher fee from both agents and
managers.
Research shows that simple, low-turnover and complex, high-turnover strategies
perform similarly on a before-fee basis, suggesting the former may have the advantage
after tax.
Simplicity leads to better investor outcomes not because simplicity in and of itself
produces better investment returns, but because a simple strategy encourages investors
to own their decisions and to less frequently overreact to short-term noise.
Munger makes the point with a fishing story: “I think the reason why we got into such idiocy in
investment management is best illustrated by a story that I tell about the guy who sold fishing
tackle. I asked him, ‘My God, they’re purple and green. Do fish really take these lures?’ And he
said, “Mister, I don’t sell to fish.’”
Captain Ron - Incentives
5. “A man’s satisfaction with his salary depends on (are you ready for this?) whether
he makes more than his wife’s sister’s husband. Why the wife’s sister’s husband?
Because (and I have a feeling that Mencken’s wife kept him fully informed of her
sister’s husband’s salary) this is a comparison that is salient and readily
available.” Availability bias
An idea or a fact should not be taken more into consideration I making a decision merely
because it is easily available to you. Shark attack or a plane crash is not more likely because it
is vivid. You are not more likely to win the lotto because you saw a winner on TV. A story bout X
that you have read recently will tend to impact your decisions more than one you read years
ago. Overcoming a dysfunctional heuristic like availability bias is a trained response.
WHY A HIGH PAYING JOB WONT MAKE YOU HAPPY - The Trut
6. “Why does cash feel so different? The agony of parting with our money has to do
with the saliency of, do we see this money going away? And it has to do with the
timing of whether the money is going away at the same time we’re consuming.”
“For example, we find that if you have a coin flip that you have a 50% chance of
making $1,100 and a 50% chance of losing $1,000. The expected value is positive,
but we don’t think of it as positive. We think, “Oh, my goodness. If I lost $1,000, I
would be very miserable. If I won $1,100 I would be happy, but it wouldn’t offset it,
so let me not take that bet.” Now, we think that the reason is evolutionary. If you
think about nature, if you get something good (like you get to eat more food and
so on) that’s a good thing, but if you do something bad, you can die. So nature
has kind of tuned us to look at the negative side because if you get a bit more
food, a bit more money or whatever, there’s a positive expected value but it’s
limited. Whereas on the negative side, you can lose a lot. So because of that we
just attune more to losses.” Loss aversion.
Michael Mauboussin writes: “One of prospect theory’s most important contributions to finance is
loss aversion, the idea that for most people, losses loom larger than corresponding gains. The
empirical evidence suggests we feel losses about two to two-and-a-half times more than we
feel gains. Loss aversion is a clear-cut deviation from expected utility theory.” Charlie Munger
puts it this way: “People are really crazy about minor decrements down. Huge insanities can
come from just subconsciously over-weighing the importance of what you’re losing or almost
getting and not getting.”
2.6 Loss Aversion and The Endowment Effect
7.”There are wealthy gentlemen in England who drive four-horse passenger coaches
20 or 30 miles in the summer because the privilege costs them considerable money,
but if they were offered wages for the service, that would turn it into work, and then
they would resign.” [Quoting Mark Twain] Anchoring
Anchoring is a tendency of people to grab on to inputs just because they are available. James
Montier describes the bias as follows: “In the absence of any solid information, past prices are
likely to act as anchors for today’s prices. For example, financial analysts often fail to revise
their estimates since they get anchored to prior numbers. (they revise too late to be
useful). Experiments have shown that if you ask a professional to work in behalf of the poor for
free you get a much better response than if you ask them to work at a reduced rate. Free work
on behalf of the less fortunate activates their desire to contribute to a community. Partial
payments tend to activate anchoring which make them unhappy since they feel they have
incurred a loss.
Human Nature - Anchoring
8. “People are always willing to take money from their future self, but then that puts
the future in danger. So we have to work on getting people to think about how much
they are really spending and also how they can invest in the future. That will take
more of an effort as technology makes spending money easier to do.” “If you think
about an environment in which we have to think long-term and abstractly, that’s just
not something we’re good at. Saving is about now versus later, it’s about concrete
versus abstract, and we don’t do those well.” Present biased preference.
A time preference can be quantified as the amount of money required to compensate the
consumer for foregoing current consumption. For example,
You could flash-fry a buffalo in 40 seconds
9. “Retirement is especially difficult because we not only don’t know exactly what
we’re giving up, it’s also far away in the future. That makes it very, very difficult to
think about. It’s called hyperbolic discounting — we just care less dramatically
about the future so not only is it hard for us to understand what we are giving up, it’s
also really, really delayed.” “If you think about the opportunity cost of money — if I
spend a thousand dollars now on a new bicycle I know what I’m getting. If I put it
into my retirement account I don’t really know what I’ll get in the future.” Hyperbolic
discounting.
Companies like Starbucks know that people will pay several dollars for a coffee house
experience even though on an annualized basis it eats up a big share of their after-tax income.
People like benefits that are available NOW—which is why they tend to not save for retirement
and eat too many calories. The investor too often says: “To heck with the 401(k), let’s buy a
waterski boat with a disco ball.”
Homer Simpson "retirement plan"
10. “If it’s more difficult to get credit, it might make people feel more pain of paying
and therefore spend less.” “I think one of the bigger problems today is how easy it is
to spend money. I see a lot of younger people who get way out of whack with the
reality of money because tech enables it. You order food from your phone because it
is easy and someone else is doing the work of making it, but that also adds up over
time. That may not be great for your finances long term because you stop thinking
about how much money you’re spending each day. That feeds into all sorts of
investment decisions over time.” Loss Aversion.
In my blog post on Richard Thaler I wrote:

“Hundreds of studies confirm that human forecasts are flawed and biased. Human decision
making is not so great either. Again to take just one example, consider what is called the
‘status quo bias,’ a fancy name for inertia. For a host of reasons, which we shall explore,
people have a strong tendency to go along with the status quo or default option.” Sales and
marketing departments love status quo bias. For example, magazines often offer free trials
or issues at a reduced price if the customer agrees that the business can continue to send
them issues until they actively end the subscription. When making decisions people tend to
follow the adage: “when in doubt, do nothing.” For this reason, getting a customer’s credit
card information is a holy grail for marketers, who hate it when credit cards expire.
Customers know this to some degree, which means they are reticent to hand out their
credit card data even for a free trial. The incentives must be significant to obtain customer
credit card data as a result.
Dan Ariely: On Dating & Relationships - Whiteboard Animation
11. “Buffett gave unsigned checks for $10,000 to his children, promising to sign them
if he was over target weight by a certain date. Many people use commitment
devices to try to keep their weight down, but Buffett’s idea had a big flaw: his
children, spotting a rare opportunity to get money from the notoriously frugal
billionaire, resorted to sabotage. Doughnuts, pizza, and fried food mysteriously
appeared whenever Buffett was home. In the end the incentives worked: even with
his children’s sabotage, the Oracle kept his weight down, and his checks went
unsigned. But had he been purely rational, no commitment device would have
been needed.” Nudging.
It is possible to use a bias that is dysfunctional for positive purposes as Buffett has done here.
Most certainly. Charlie Munger has said: “The system of Alcoholics Anonymous: a 50% no-
drinking rate outcome when everything else fails? It’s a very clever system that uses four or five
psychological systems at once toward, I might say, a very good end.” Richard Thaler tells this
story to talk about why people need help:
I was having a dinner party for fellow economics grad students. Before dinner I served
some cashew nuts along with cocktails, and everyone kept eating them. Soon their
appetites were in danger, not to mention their waistlines. I grabbed the bowl and hid it in
the kitchen. People were (a) happy, and (b) they realized their reaction conflicted with
traditional economic theory. Econs are better off with more choices. We humans actually
need help controlling our impulses—nudges.
12. “Our irrational behaviors are neither random nor senseless- they are systematic
and predictable. We all make the same types of mistakes over and over.” “One of
the most underused interfaces in human decision-making is the calendar. If you
think about it, the calendar does many, many things wrong. But one of the
interesting things about the calendar is that when you have something there that
is set there’s a good chance that you will actually go ahead and do it.” “I want to
know if we can start building ways of preventing risks. Can reminders really help
people? We all know that you get a lower price on auto insurance if insurers think
you are less likely to speed. What if we started sending reminders to people about
speed or remind them of some of the long-term consequences that could result
from speeding?”
Another example of a dysfunctional bias involves what a New York Tines reviewer of
Predictably Irrational pointed out that: “People aren’t just loss-averse; they are also effort-
averse.” They also have status quo bias. Some countries have an opt-in system for organ
donation. The direction they give is: “Please check this box if you would like to participate in the
organ donation program.” Other countries have an opt-out system. This result of this choice
architecture is striking.
That brings this

post bask to the
first point above.
Airley says that if
you ask people
why they made
their organ
donation choice
the inevitably
come up with a
story that
somehow justifies
their decision
regardless of
whether it is yes or
no.
Richard Thaler - Nudge: An Overview
Notes:
Not released yet:– Dollars and Sense: How We Misthink Money and How to Spend
Smarter November 7, 2017 https://www.amazon.com/Dollars-Sense-Misthink-Money-
Smarter/dp/006265120X/ref=sr_1_7?ie=UTF8&qid=1503168432&sr=8-
7&keywords=dan+ariely
Dan_Ariely, The Honest Truth About Dishonesty: How We Lie to Everyone–Especially

Ourselves
Dan_Ariely, Payoff: The Hidden Logic That Shapes Our Motivations

https://www.amazon.com/Payoff-Hidden-Logic-Shapes-
Motivations/dp/1501120042/ref=sr_1_3?ie=UTF8&qid=1503168432&sr=8-
3&keywords=dan+ariely
https://rpseawright.wordpress.com/2011/11/01/five-good-questions-with-dan-ariely/
http://www.thinkadvisor.com/2010/04/01/cover-story-the-upside-of-irrationality
http://www.slate.com/articles/business/the_united_states_of_debt/2016/06/how_to_get_out_of_debt_according_to_behavioral_e
Click to access SpillerValueOfMoney.pdf
http://www.rewire.org/our-future/credit-cards-feel-good/
http://www.newsweek.com/economy-return-cash-and-carry-model-87541
http://www.institutionalinvestor.com/article/3561826/investors-registered-investment-
advisers/dan-ariely-seeks-to-save-irrational-investors-from-
themselves.html#.WZhnJ7pFxVg
https://www.fool.com/investing/2017/04/17/an-interview-with-behavioral-economist-dan-
ariely.aspx
https://blogs.cfainstitute.org/investor/2016/07/05/dan-ariely-on-the-power-of-irrational-
thinking/
https://www.cbsnews.com/news/think-about-money-dan-ariely-challenge/
Buffett and his attempts at self-control
http://fortune.com/2017/02/23/investment-psychology-recency-bias/
http://scienceblogs.com/cognitivedaily/2008/10/21/dan-ariely-at-davidson/
http://bookoutlines.pbworks.com/w/page/14422685/Predictably%20Irrational
https://www.betterment.com/resources/personal-finance/goals-and-advice/dan-ariely-
author-of-predictably-irrational-on-betterment/
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25.09.

Home About Featured Individuals & Topics Book Recommendations

A Dozen Lessons about Investing and Money from Dan

Dan is a Professor of Psychology and Behavioral Economics at Duke University and

The Exciting World Of Frame Nudging! (The Simpsons)

Herd Behaviour (explained in a minute) - Behavioural Finance

Charlie Munger is a strong believer in making decisions based on opportunity cost.

Captain Ron - Incentives

2.6 Loss Aversion and The Endowment Effect

Human Nature - Anchoring

You could flash-fry a buffalo in 40 seconds

Homer Simpson "retirement plan"

In my blog post on Richard Thaler I wrote:

Dan Ariely: On Dating & Relationships - Whiteboard Animation

That brings this

Richard Thaler - Nudge: An Overview

Dan_Ariely, The Honest Truth About Dishonesty: How We Lie to Everyone–Especially

Dan_Ariely, Payoff: The Hidden Logic That Shapes Our Motivations

Click to access SpillerValueOfMoney.pdf

Buffett and his attempts at self-control

← A DOZEN ATTRIBUTES OF A SCALABLE A DOZEN LESSONS ABOUT BUSINESS AN D

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