Motley Fool Money - Hidden Gorillas and Predictable Irrationality

Episode Date: June 1, 2018

On this week's show, we revisit some of our favorite conversations about investor behavior. Best-selling author Carl Richards talks about the benefits of the overnight test. Christopher Chabris talks invisible gorillas and intuition. And Dan Ariely talks investing and irrationality.   Learn more about your ad choices. Visit megaphone.fm/adchoices

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If you're 45 or older and at average risk, ask your health care provider about the Coligard test. Colagard is available by prescription only. Learn more or request a prescription today at colagard.com slash screen. Everybody needs money. That's why they call it money. From Fool Global Headquarters, this is Motley Fool Money. Welcome to Motley Fool Money. I'm Chris Hill. This week, we're hosting Fool Fest here in Alexandria. It's our annual two-day investing conference. But don't worry, we've got a special edition of Motley Fool Money on tap.

Warren Buffett has said that the most difficult thing he had to master as an investor was not numbers or analysis. It was his temperament. So on this week's show, we're featuring three of our favorite interviews, all dealing with investment behavior. We've got Christopher Shabree, author of The Invisible Gorilla, Dan Ariely, on the upside of irrationality. But we begin our show with best-selling author Carl Richards, author of The Behavior Gap, Simple Ways to Stop Doing Dumb Things with Money. I want to spot you up with a few chapter headings and have you expound on them. And the first chapter in your book, We Don't Beat the Market, The Market Beats Us.

Wow, that's a little depressing. Yeah, I mean, there's a lot to talk about there, but I think one is making mistakes. You also blog for the New York Times, and one of your recent blog entries, you wrote that everyone should use the overnight test. For our listeners, if you could, please explain the overnight test. traditionally attached. It's an exercise, people. Come on.

You wake up in the morning and you just have cats. Probably my favorite heading of any of your chapters is Chapter 6, which is entitled, Plans Are Worthless. Carl, you're a certified financial planner. Tell me you're not using that as part of your marketing. When you look at the universe of dumb moves when it comes to money, what do you think is the single dumbest mistake that investors make? The only thing is American.

Well, so that leads to a question that we frequently get here at the Motley Fool, and that is the question of, when do I sell a stock? So whether it's in your own life or working with a client, what are the questions, the processes that you go through when deciding whether to sell a stock? Mental belief, right? So we've got to ask the question. You know, you can always drop us an email.

Radio at Fool.com is our email. address, that's radio at fool.com. Coming up, more with Carl Richards. Stay right here. You're listening to Motley Fool Money. You've got the money. I got the time. We'll go honky talking. Welcome back to Motley Full Money, Chris Hill here in the studio, talking with our guest Carl Richards about his new book, The Behavior Gap. For someone who is looking to work with a financial planner, what are a couple of questions that they should be asking. I think a lot of people are interested in working with a financial planner,

but maybe aren't really, they feel like they're walking blind into the interview process. What are a couple of key things anyone should ask when it comes to working with someone with their money? The advisor is competent. You're listening to Motley Fool Money? Warren Buffett obviously has had an amazing track record of success. when you look at his career, what do you think is the secret ingredient? I hadn't heard that one before. Yeah.

Statistically, it's really challenging to say whether... And I have to plug you for a little bit of free consulting on the financial planning. What are a couple of things that everyone can do to get their finances in order? I touch it, and it's... Now we talk Invisible Gorillas with Christopher Chabree. So what do smart chess players and stupid criminals have in common? Should you be more like a weather forecaster or a hedge fund manager? Is it always better for investors to have more information?

Chris Chabree is a professor of psychology and neurology. He's a chess master, and he's the author of the just-release book, The Invisible Gorilla, and other ways our intuitions deceive us. Chris, welcome to Motley Full Money. Thanks for having me. Let's start by talking about Invisible Gorillas. For those who aren't familiar with the famed experiment, can you give us a quick overview and what is the main takeaway?

Sure. The title of our book refers to an experiment that Dan Simons and I did at Harvard University about 12 years ago. It was a very simple experiment. We created a video which showed two groups of three people passing basketballs back and forth. One of the groups was wearing white shirts and the other was wearing black shirts. And the white-shirted people passed the ball among themselves and the black-shirted people passed a ball among themselves. about halfway through this 60-second long video, a person in a gorilla suit saunters into the game,

turns to face the camera, thumps its chest, and walks off at a leisurely pace, remaining on the screen for about nine seconds. We showed this videotape to people, and we asked them to count the number of passes that the white players were making. And then at the end, we asked them how many passes they had counted, and we said, did you see the gorilla? And the surprising result was that about half the people who saw this video did not see the girl at all. And they accused us of switching the tape and of making it up and all kinds of things. But in reality, there was a gorilla there, and about half the people didn't notice the gorilla. So it shows really two things. One, we're missing a lot of stuff in our world around

us. If we can be missing a gorilla walking through a basketball game, what else are we missing? But two, we're not really aware of how much we're missing. We're surprised to find out that we don't pay attention to as much as we think we do and we don't notice as much as we think we do. and it seems that we have a lot of other ideas about how our own minds work, which are similar to this one. They're sort of predictably wrong in surprising ways. Should you be more like a weather forecaster or a hedge fund manager? Which is it?

Well, it really depends, of course. If you're trying to forecast the weather, you probably want to be more like a weather forecaster. The question is really meant to get at the idea that there are some areas of knowledge where it is really possible to know how much you know and how much you don't know. People complain about weather forecasters all the time because sometimes they get it wrong. But when you actually look at their track record, when they say there's a 75% chance of rain, if you look at all those days when they said 75% chance of rain, it actually rains 75% of those days. So they're not perfect.

They don't say 100% all the time and 0% all the time, but they're actually very well aware of how much they know. And if they say 75%, that's pretty much correct. On the other hand, there are many famous cases of hedge fund managers who made tremendously large bets on particular ideas about the direction of markets. We tell the story in the book of Brian Hunter, who was a trader in energy futures, and he bet billions of dollars on directional movements in natural gas prices, did well for quite a while, and then blew up his fund completely. and that's the kind of thing that someone with an awareness of how little they really know about the system they're trying to model would probably not do. We've got more with Chris Chabree as we discuss mutual funds, poker, and snap judgments. Stay right here. You're listening to Motley Full Money. I got my youth and hell.

What do I want with wealth? Money is the root of all evil. Welcome back to Motley Full Money. Chris Hill. We're talking to Christopher Shabree, the author of The Invisible Gorilla. One of the other questions in the book that you get at that mentioned right at the top, what do smart chess players and stupid criminals have in common? Well, that's another funny one, I think. Chess players and criminals usually don't seem that much alike,

but there's one way in which they're quite alike, and in which they're in fact like all of us. They are overconfident in their own abilities. So let's take the criminals first because they're a bit funnier. There are many examples of stupid crimes. For example, a guy named MacArthur Wheeler tried to rob some banks in Pittsburgh without a disguise in broad daylight. And the reason why he thought he could get away with this was that he rubbed lemon juice on his face, thinking that that would render him invisible to security cameras, much like, I guess, children writing in lemon juice think they're writing.

and invisible ink and invisible messages and so on. Of course, they broadcast the security footage of him, and he was caught an hour later, and he seemed incredulous when he told the police that his method didn't work. He was very incompetent as a bank robber, but at the same time, woefully overconfident of his abilities as a bank robber.

And what research has actually showed with cleverly designed experiments is that the people who are the least able at something are often the most overconfident or the most confident in their abilities. chess players have a rating system that tells them exactly how good they are. You know, if you're a bank robber, you don't really have like a numerical rating system that tells you how good a bank robber you are.

Right. I think Morningstar is working on something like that, like a five-star rating for bank robbers. Right. Well, if they could get it, if they could get it right for mutual funds, that would be a start. The fact is that in almost all fields, we don't have perfect feedback about how good we are. In chess, we do. There is a rating system in chess, which is very well calibrated, and it tells you exactly how likely you are to beat somebody else based on your two ratings. We surveyed chess players at large chess tournaments and found out that despite having this really high-quality information available to them, and they all know it, they still thought they were much better than they actually were. So there's this sort of innate tendency to think that our skills, our knowledge, our abilities are better than they actually are,

and that can obviously get us into trouble when we're making investing decisions or managing other people's money. One of the things you write about is an experiment involving two mutual funds, and the subject has a choice. They can receive feedback and be able to change their allocation every month, every year, or every five years. As investors, how often should we want that information? Well, we posed this sort of as a thought experiment. If you were an investor, how often would you want to get the information about how your funds were performing and the chance to change the allocation? And I think the answer that most people would give is as often as possible. And in fact, we can do that every day right now is generally the way things are set up.

But in this experiment, which is done by behavioral economist Richard Thaler and some of his colleagues, it turned out that the subjects who are randomly assigned to get feedback only once every five years had the best track record over about a 30-year period of performance than people who got feedback every month. Of course, this was not a 30-year-long experiment. This was simulated time and simulated time periods. but the result was the same, actually having less information about your performance and about how the market was doing resulted in better performance. The reason for that is that the two mutual funds in this experiment simulated mutual funds, one was a bond fund, so it had a very low return, but also very low volatility, and one was meant to be like a stock fund, so it had high return but also high volatility. So people who allocated money to the stock fund found that sometimes they suffered large losses month to month, as the stock market is want to do, and that made them move out of the stock fund.

into the bond fund, but over the 30-year period, it was a bad idea to have all your money in bonds, so those people didn't wind up making that much money. They got a lot of sort of short-term information about volatility, and that obscured them from understanding the long-running trend in the market. You're listening to Motley Full Money. We're talking with Chris Chabree about his new book, The Invisible Gorilla and Other Ways Our Intuitions Deceive Us. Now, in addition to writing the book and all of your work. You're also a chess master. What game do you think investing most approximates?

Well, the obvious answer is something that has a little bit more gambling in it. If I had to choose, though, I think the right game I would pick is something more like poker. A lot of people sort of analogize investing to a casino and so on, and to the extent that it has those characteristics, that's probably bad. But a game like poker involves both skill and chance. You know, you can have the edge if you study and if you practice, and especially if you know yourself. And one of the big ways to have an edge in poker is to get control over your own emotions and to understand when you're acting impulsively and when you're not thinking things through and you're not thinking long term. And, of course, those are the same characteristics that I would think investors would want to have also.

You don't want to be making decisions based on intuition, gut instinct, and so on. You want to be making them on a long-term plan that you can stick with and sort of use to ride out emotional stuff. swings. All right. Before we let you get away, we got to end with a quick round of buy-seller hold. Let's start with, well, you know, Malcolm Gladwell wrote a bestseller entitled Blink, based on this concept. Buy-seller Hold, Snap Judgments. I'm going to say, I'm going to say sell Snap Judgments. I wouldn't hold on to them right now. I think they're quite overrated, and it's not necessarily Malcolm Gladwell's fault. I actually enjoy his book very much, but I think people have somehow taken the lesson from his book, and from a few things

that he says in that book, kind of isolated sentences, that the world would be a better place if we all trusted our guts more. And, you know, one, I was reading a fascinating book that I'm sure a lot of others have read, too big to fail, and it talked about what happened with Lehman Brothers, and it turned out the president of Lehman Brothers, as they were sort of circling the drain, 2007, 2008, was a big devotee and had exhorted all of his, you know, all of his friends to go with their guts and so on. And I think there are some situations where it is good to trust your intuition, your gut instincts, you know, deciding what kind of ice cream you like and what you want to eat and so on. But investment decisions and really weighty matters might be a good time to step back and go for a little more rational analysis. So I'm going to sell those right now.

This is a film about confidence men by Seller Hold, The Sting. Oh, I would definitely buy that one. Now that you mention it, I haven't seen it in years, but now that you mention it, I think I'm going to check it out again. Confidence men, a lot of people don't know that the phrase, con man is short for confidence man, and that was the original phrase a long time ago. And it's a great example of that phenomenon.

If you just look at the, you know, you look at the Madoff case, He was a guy who was supremely confident. People went and interviewed him, and he betrayed no signs of unease or that anything was going wrong with his business. When he talked to outsiders and future investors and so on, up until close to the very end. So, you know, getting back to this thing, I would definitely put a buy on that one. And finally, your book is on sale everywhere, including Amazon.com. Another book that I found on Amazon.com is entitled Practical Intuition in Love. let your intuition guide you to the love of your life.

Now, you and your co-author are both married. So buy-seller hold the role of intuition when dealing with one's spouse. I thought you were going to say when finding a spouse. And in that case, I was going to put a buy on that one, because I think attraction is one of those areas where a lot of rational analysis is not going to tell you who you'd be attracted to and who you shouldn't be attracted to. So I would go with intuition there. Now, as far as dealing with your spouse,

That's a different question. So now I'm going to actually answer the question you posed. And I would on that one, I'd put a hold because here you've got two sides of intuition involved. One is you want to be sensitive to how someone's feeling. You want to be sensitive to your own emotions and all that kind of stuff. And I'm not really that kind of psychologist, but I can appreciate that. But two, you want to be aware of when you're making assumptions about things like who remembers what and who said what when and what people know and what they don't know.

and a lot of arguments I've noticed after I wrote this book, the more I started to look at my own behavior and my own life, a lot of the things we argue about are based on people thinking they have perfect memory of what happened in the past. You said that two weeks ago. That's exactly what you said. I remember exactly what you said, and you can get into too many ridiculous arguments with your spouse,

other people in your life, and so on, if you really believe that you are perfectly aware of what's going on and you have perfect memory and your knowledge is better than everyone else and so on. So I would really watch out for those kinds of intuitions, the kinds of intuitions about how your mind works and how good you are, which are the ones we're really sort of warning about in this book. So on balance, I'd have to give it a hold because that's half a buy and half a sell. The book is The Invisible Gorilla and Other Ways Our Intuition's Deceive Us. It is available everywhere.

Chris Shibri. Thanks so much for being here on Motley Full Money. Thank you. Coming up, a look at irrationality and investing with bestselling author Dan Ariely. This is Motley Full Money. As always, people on the program may have interest in the stocks they talk about. Don't buy ourselves stocks based solely on what you hear. Welcome back to Motley Fool Money.

I'm Chris Hill, and we wrap up this week with best-selling author and behavioral economist Dan Ariely. And we begin the conversation by talking about how investors should behave. Dan, the market is up from its lows in 2009. A lot of investors have seen their stocks regain some of that lost ground. How do you invest your own money? and how do you find yourself reacting when your investments go up? Yeah, so I try not to react. And I mean it seriously.

So people do lots of mistakes when they invest. And one of the mistake, of course, is to let emotion rule us. So here's kind of a way to invest badly. Is you start in the morning and you get to the office and you open your portfolio. And, you know, if you're up, you're a little happy, and if you're down, you're really miserable. and now you make your decision based on this particular emotion that was evoked by the randomness of the stock market. And I try to think about this strategy without looking at my portfolio. So I don't look at specific things that I gained or lost because, you know, that's kind of water under the bridge.

It's not very helpful and I don't want to be emotional, but I can look at it and say, what do I think about the future? Where do I think things are going up? When do I think things are going down? and let me take an action of those, independent of how much money I've lost in the past. It's kind of irrelevant. That's the first thing. And the second thing is that I try to avoid

the status quo bias. So what happened is that you create a portfolio and you open it, and now the question is, what do you change? Like, what do you sell? What do you buy? How do you change your portfolio to a slightly different portfolio?

And that means that whatever decisions you made in the past, rational, irrational, thoughtful, not so thoughtful, is going to keep on escorting you through life. And what I try to do is try to imagine once in a while that somebody went at night and somehow sold everything I have. So I'm just cash. And now I sit and I say, okay, assuming I just have cash, what would I get now? And that basically help you alleviate some of the problems. Imagine you bought a stock for 100 and it's now 80.

It's very painful to sell it, even if you think it's going to go down. Right? So people often hold on to losing stock for too long. So from time to time, it's good to start from scratch. And imagine you just have cash, say, what would you do now, and then move on on this strategy. The subtitle of your book is The Unexpected Benefits of Defying Logic at Work and at Home. I want to ask you, in general, how do we act irrationally at work? So big bonuses is one example, where we pay people tremendous bonuses. we think they will work better.

And in fact, big bonuses really work very well for physical tasks. So if I wanted to do to jump many times, you will jump more if I gave you high bonuses, but they backfire for cognitive tasks. Other ways in which these things work is that people fall in love with their own ideas. They fall in love with the things that they make. They don't see the downside of anything that is connected to us. We are wonderful people. We're exceptional, and therefore everything we touch, all the ideas we come up with.

are exceptional as well, and I talk a little bit about revenge as well. And there's actually one chapter that I think is particularly interesting and kind of starts, I start in the book from a story about the financial industry, which is a chapter about the meaning of work. And the story is that one of my ex-students came back to visit me, and he told me that he worked for three weeks on a PowerPoint presentation for some big merger. And he sent it to a boss a day before the merger, and the boss said, nice work, but the merger is canceled.

And that guy was completely devastated. He was completely unmotivated in the next task he was going to do. And he said everything, functioned was just perfectly fine. Everything functional. His boss appreciated it. He worked hard on it. He enjoyed it while he was doing it. He was sure he was getting to raise.

Everything seems perfectly functional. But at the same time, he was completely demotivated. So we created the following experiment to capture this. In one condition, you build robots from Lego, and you get paid for them less and less the more you build. So you get $3 for the first one. And when you finish, I say, Chris, you want to build another one. You'll get $2.70 for that one. You say, yes, I give you the next one.

I say, hey, do you want another one? You'll get $2.40 for the next one and so on, until you decide, at this price, I don't want to build them. This is one condition. And I tell you that when you finish building all of them, when you finish the experiment, I'll unassemble them, put them back in the boxes for the next participant. For the second group of participants, you build the first one. I said you want the second one. As you build the second one, I already take the first one to pieces.

I break it up to pieces already and put the pieces back in the box. And if you want to build the third one, I give you the first one back, the one that you build and I unassembled and you can assemble it again. So what happened? Two things happen. The first thing is that in this condition, which we call the specific condition, people stopped working much faster. And the second thing is for everybody,

we measured how much they like Legos and how long they persisted in the task. And what we found was in the first condition, when we didn't kind of crush the meaning of labor, there was a high correlation between how long people persisted in a task and how much in general they liked Legos. But in the specific task, the correlation was basically zero. Which tells me that we were able,

with this very simple manipulation, squish the joy that people were having from these tasks. People are capable of creating lots of intrinsic value and motivation from tasks. Even tasks that are not so meaningful, like building robots from Lego for a few minutes, but we as job places can easily squish the joy out of those things. And I think the challenge for the workplace is to say, how do we want help people get more value out of their work? How do we explain to them the value of what they're doing, the connection to other things,

the meaning in their work? And, of course, how do we not make it worse? How do we not kind of crush the feeling of meaning that people can naturally create in their labor? You're listening to Motley Full Money. We're talking with Dan Ariely, author of The New Book, The Upside of Irrationality. Dan, time to close thing out with a round of buy, seller, or hold. Let's start with something that a lot of businesses use. Buy-seller-hold focus groups.

Sell, sell, sell. Why? Because it turns out that focus group give people lots of confidence that they learn something and they know what they're doing, but the actual value in terms of information is really, really low. It's kind of the same value as you get

from listening to people who analyze at the end of the day what happened in the stock market and tell you exactly a story about why they can predict what happened in the past. people are really good in telling stories about what happened, even when they have no idea about what is reality. All right. You write about the biological imperative for variety. So buy, sell or hold, monogamy. Are you trying to put me into a tough spot here? If I had to bet, I would sell. Tell me why.

So monogamy is an incredibly, incredibly hard thing to maintain. And it turns out that one of the interesting thing that controls monogamy is a drug called oxytocin. And so if you give people oxytocin, they become more trusting and more monogamous. But we don't have that much oxytocin. Some animals have more, some animals have less. We are not, we don't have a lot of it. And, you know, I think that despite the fact that we get up, upset with the tiger words and other politicians when we discovered that they've not been

monogamous, the reality is that most people are not. So we have kind of this double standard. When this thing happens in society all the time, we just don't seem to admit it to ourselves that this is incredibly much more common than it is. And you know, the reality is that people do other things from time to time. That's just how things are. And finally, you're a married man. I'm a married man.

Buy seller hold telling your spouse they're not being rational. That's definitely. You never, never, never want to do that. Never, never, never. So you've never gone there with your lovely bride, Sumi. With my, my lovely wife, let me say it again, my lovely, lovely wife, who's incredibly generous and forgiving on a daily basis. No, telling her is irrational is not the right thing.

First of all, she's always rational. I'll always make the hard decision, but no, this is not the right standard to have a discussion with your significant. The book is the upside of irrationality, the unexpected benefits of defying logic at work and at home. It's available everywhere. It is a fascinating read, so pick it up. Dan Ariely, thanks so much for being here. My pleasure is always. That's it for this week.

If you miss any part of the show, you can find it at our website, motleyfoolmoney.com. Our engineer is Steve Broido. Our producer is Mac Creer. I'm Chris Hill. Thanks for listening. We'll see you next week.