Poor Decision Making Is in Our DNA

Humans routinely make irrational decisions. We make predictable mistakes and, even knowing we are biased, we continue to make the same mistakes. This is particularly true with many financial decisions, as has been evident in recent times. In a recent talk at TED, Laurie Santos presents some fascinating evidence that poor economic thinking has been in our DNA for at least 35 million years.

Santos trained capuchin monkeys, cousins with whom we shared an ancestor 5 million generations ago, to handle money and engage in economic activity. It’s a great experiment. And they make all the same dumb mistakes that humans make! Humans and monkeys:

• Cannot think in absolute terms. We prefer to think in relative terms.
• Are loss averse. We hate losing money and will do dumb things to avoid it.

Which of these two alternatives would you choose?

1. I give you £1,000 and then toss a coin. If it comes up heads I give you another £1,000. If tails, you get no bonus but can keep the original £1,000.
2. I give you £1,000 plus a guaranteed bonus of £500.

Most humans and most monkeys choose option B, and if you are risk averse this is the rational choice—it has a higher certain equivalent.

Now consider these two choices.

1. I give you £2,000 and then toss a coin. If it comes up tails I take back £1,000. If heads, you keep the full £2,000.
2. I give you £2,000 and then take back a fixed £500.

Most humans and most monkeys now choose option A. But think for a moment. The situations are the same. With A you have a 50-50 chance of ending up £2,000 or £1,000 richer than when you started. With B you are guaranteed to be £1,500 richer. But the second situation involves giving something up that, even if only for a fleeting moment, you owned.

This is loss aversion and it is irrational. The half chance of not incurring any loss is preferable to the guaranteed loss.

Application to real life

The biggest example of loss aversion that I regularly come across is in the deep reluctance that many pharmaceutical clients have to killing a project. It is clear that the compound probably has no economic or scientific value and the rational choice is to stop funding it. But they just cannot bring themselves to do it. The use of the word “probably” means that “possibly” it might still be a blockbuster. That was the rationale that started the research in the first place, and people find it hard to give it up.

What about you?