Why we make bad decisions about money

Daniel Kahneman: Why We Make Bad Decisions About Money (And What We Can Do About It)

One of weaknesses of human's decision-making (about money): it is called "Narrow-Framing". People tends to frame things very narrowly. They deal with a problem at hands as they think that is the only problem. People save and borrow at the same time, instead of treating their whole portfolio or assets as a whole. People will make better decisions if they take broader views.

Mental-accounting is a big deal, we keep our money in mental-accounts for which we have different rules. People also spending their money, but there is a hierarchy of the accounts that they will touch: they will spend money that they have stored for their vacations, quite often before they will spend whatever they are thinking for the savings for their children's education. So those are mental-accounts for which people have different rules. More foolishly, because mental-accounting is a tool of a self-control but investors tend to view each stock they buy as a mental-account and they want to sell it when it is a winner. So they tend to sell their winners and just hang on to their losers in their portfolio, which certainly make them poorer than if they had done things differently.

You need to be numerous for certain kind of decisions, numerous people has certain kind of advantages over those who are not, understanding compound interest makes a huge difference whether you're a credit card borrower or somebody with saving. People have a very hazy idea of compound interest and it's very detrimental.

So, first of all you should be numerous, then you need to frame things broadly. It frequently goes with numeracy but it's not quite a same thing. By taking a broad view, it is very important not to have overly strong emotional reactions to events. Most of us tend to respond to gains and to losses to changes that happen in our life. Actually, you'd better off if you frame things broadly, and you think of you win a few you lose a view, and you have very limited emotional response to small gains and to small losses. That tends to induce better decision making.

Daniel Kahneman: "Thinking, Fast and Slow"

How to respond to gains and losses and decision-makings under uncertainties.

About intuition, naturally there are 2 camps, pro and con.

Read Malcom Gladwell "Blink" (although it is not unconditional defense of intuition, but it certainly gave people the impression that sometimes we magically know things without knowing why we know them).

Within the discipline of psychology and decision making, there is a group headed by Gary Kline who wrote "Sources of Power" (recommended to read). They are a great believers in expert intuition. On the other side they are skeptics about intuition in general including expert intuition.

Kahneman's is one of the skeptics, in his early works with Amos Tversky was about intuitive errors and flaws and biases of intuitive thinking.

In medicine, there two popular writers with different views: Jerome Groopman and Atul Gewande. Atul Gewande is in favor of formal systems, very skeptical about human judgment and wanting to prove all the time and Jerome Groopman really like old-fashion-medical intuition (he of course like well-educated physicians, but he doesn't like formal systems and the issue in the medicine is "what are the role of evidence based medicine how do you allocate that with function of the intuition?")

Part of the background of this talk is a strange collaboration between Kahneman and Gary Klein, as a guru of people who think that the emphasis and biases of judgement has drawn an unjustly unfavorable picture of the human mind. After working together to seek the boundary, about where is institution marvelous and where is it flawed, they wrote under a title "A failure to disagree". On the substance, we know and we both agree where you can trust intuition and where you cannot.

There are two modes of thinking. One mode: when we see a picture of woman with 'angry face', we know right away that she's angry. This is one way of thoughts where we judge based on our passive experiences.It is true impression and general, that we call "intuitive thinking" because it just happens, comes from somewhere, we are not the author of it.

Another way when you see 17 x 24, nothing come to mind, the the answer is 408. To produce 408, requires a completely different kind of operation. You have to retrieve the program that you learned in school, the program consists of steps, you have to go through the steps, you have to pay attention successively to partial products, and so on, and keep the whole program in mind. THis is something that you do and not something that happen to you.

There are many indications how it works. One is that physiology indicates how it works: pupil dilates, this area will increase 50% and it will stay dilated as long as your head's working and collapse back to normal size either when you quit or when you find the answer. Here we feel a sense of urgency. We feel something deliberate is happening and a very important aspect of it this is effortful, and what psychologists mean by effort is basically something you cannot do while left turn into traffic. You cannot do it and you shouldn't try. The reason is there is limited capacity to exert effort (not for multitasking).

Another function of system 2:

A bat and a ball together cost $1.10 The bat costs a dollar more than a ball. How much does the ball cost?

The point about the riddle that is the number come into your mind which is 10 cents, but it is wrong because 10 cents and 1.10  is $1.20

So the answer is 5 cents.

50% of students answer is 10 cents.

We learned it why they answered 10 cents, it was because they didn't check.

So there's a sense of confidence that people have, brings us to another system: System 2.

System 1 is about intuitive (automotive and activity); system 2 is effortful (deliberate).

System 2 is self-control and controlling your attention and deliberate exertion of effort are impaired when by other activities. For example, if you give someone a difficult calculation and at the same time to choose between a sinful chocolate cake and a healthy salad, they will choose the chocolate cake. It takes some efforts to control your impulses.

You should be aware of differences between the automatic operation-system 1 and the deliberate operation-system 2, that is shown very clearly in driving. Driving is a skill. For any skilled activity measures is that things happen automatically. You can drive and conduct a conversation. Driving is largely automatic. Braking, when any signs of danger, is completely automatic and the response is immediate. System 2 will be mobilized when you drive on the ice, to skid, completely non-intuitive. But when people have lot of practices to skid, that it will to become automatic.

So system 1 is also where the skill is, not only because naturally happens.

So intuition is not a magic of all and we should understand how it works.

Herbert Simon (psychologist, economist, nobel laureate) define what intuition is: recognizing.

Some persons have opportunities to learn irregularities in this world. Like a chess and poker player, there are rules. There are also rules in the environments that when we are exposed to them for a long time, and we get immediate feedback, we would acquire those feedback on what is right and wrong.

So all of us are expert intuition. One can recognize his wife's mood from one word on the telephone. All can recognize dangerous driver on the right lane. We get cues and we don't necessarily know what is the cue but this person is driving erratically and could do something dangerous. This is a lot of reinforced practice, and we're very good at that. We can learn about those. The level to develop intuitive expertise are difference among the professions. You could expect anesthesiologist to develop intuition much more than the radiologist. Because one get very good and immediate feedback, because they have all the measurements in time, while the other one get really miserable feedback about whether they're right or wrong. So this is part of the answer of intuitive expertise.

That also means that intuitive expertise is not going to develop in a chaotic world. For example, Kahneman cannot believe that people investing in stock markets can develop intuition because simply the market takes care of it. The reason there isn't enough regularity in what's going on to happen to prices for intuitions to develop. In political forecasters, when they forecast for long-term they will know much better than the dart-throwing monkeys, but certainly not better than the average reader of New York Times.

No one can predict long-range 10 to 15 year in future. They are quite good at short-term predictions. It is not their faults, but it is the fault of the world. The world is probably not predictable, so you are not going to predict it.

When there are marginal situation, there is some predictability but poor formulas do better than individuals, the domain where the formulas beat the individuals regularly is a domain of fairly low predictability. Because when there are weak cues, people are not very good at picking them up, and are not good at using them consistently.

But formulas can be generated on the basis of experience, and they will do a better job than an individual judgement.

We sometimes have intuitions that applies to political forecasters and stock pickers and to all of us, and frequently the intuitions are false. They come to mind and are subjectively indistinguishable from expert intuition. People who have intuitions that are not based on expertise, but come in system 1 (automatic and effortless).

System 1 and system 2 introduction is not supposed to be done, because psychologists told that you are not supposed to explain what happens in the mind by invoking little agents inside the mind and explain what the mind does by what the little agents do. Those are homonculi and that's a bad word in psychology.

So Kahneman's defense is: those are fictitious characters, they don't exist. I don't believe there is such system 1 and system 2 in the brain which one does one and the other does the other.

Joshua Foer's book (recommended) "Moonwalking With Einstein". Joshua went to memories championship, before to observe and the next year he won the championship. The story was known to the Greeks as "memory is very very good at something and terrible at other things". Memory is terrible at remembering lists. Memory is superb at remembering routes through space. The evolution has endowed us with an ability to remember routes and not lists. So you can trick yourself. So if you have a list, then you create a mental route and you distribute the items on your list along the route.

It also happens in another context. People are very good thinking about agents. Agents have traits and behaviours. We form global impressions of their personalities. We are not very good at remembering sentences, where the subject is an abstract notion.

In system 1, a lot is happening in our mind that we are not fully aware of. There is a link between eyes and being watched, being watched and not wanting to do bad things, or wanting to do good things, all of those are deep in our associative memory, and it gets activated.

Banana                     Vomid

You don't choose to read it, you just read it.

When people exposed to threatening word, they move back. So the threat to some extent taken to be real. The symbolic threat is taken to be real. You made a disgust face, you experienced disgust. Interestingly because those things are reciprocally reinforcing. So if you make a disgust face, you are more likely to feel disgust. If you make smiling face, you are more likely to feel it funny. If you take a pencil, and stick in your upper mouth, a cartoon will appear funnier to you because it is just the same as you smile.

So just a sheer of muscular change is enough to feedback into our emotions and our feelings.

So system 1 is related to associative memory. Like a gigantic network of ideas, and the ideas are linked to each other in various way, associatively, some are causes of other things or categories. There is a huge presentations of what we have in mind. At any one time, a stimulus occurs, it activate a subset of those notes in that representation of memory and then activation spreads through the associative network, not a lot but it spreads some. We become sensitized to other ideas that have been activated. If somebody whispered words in your ears, you will likely to detect and recognize words like sickness, smell, instinct, nausea, and hangover. Because those ideas have been partly activated, weak stimulus is going to be sufficient to bring them over threshold. This is the function of system 1 associative memory. We are prepared by this spreading activation for what might come next. You will be able to recognize and respond to things more easily than before.

Here there are two words: banana and vomit, and you make a story to create a causal link.

In system 1, everything is made coherent. The ambiguous stimulus:

A 13 C

12 13 14

Depending on the context, in the context of letters, it is going to read as a letter, in the context of numbers, it is going to read as a number.

One is coherent, the other one is you are not aware of the ambiguity. The ambiguity is suppressed that you just get one interpretation i.e. coherent interpretation. System 1 generates associatively coherent representations of reaction to situation.

Associative memory of system 1 is also very pository of the world knowledge. So when an event occurs, our reaction to it is informed by a lot of things that we know.

Upper class-British male voice " I have tattoed all my body".

The system 2 works to pay more attention. Because surprise calls attention.

This system holds a world knowledge and uses it to classify situations as normal or abnormal, and it updates very quickly. The second time we will not be very surprised. It takes very fast to take it as a norm.

About causal thinking and a judgement of probability based on the confidence that we experience. Even before you do the math, your reasoning flows along causal lines intuitively. When you feel it okay, it feels more coherent and the coherence we experience can be turned into a judgement of probability.

People have intuitions that are not necessarily true. People are confident in judgements but are not necessarily true.

A mechanism of substitution: substituting an easier question for a hard one.

It happens automatically and people are not aware of it and it is a source of many intuitions that don't come from expertise and they are much less likely to be correct than intuitions that come from expertise, with same confidence.

"The mental shotgun". When you are instructed to do one operation, you will perform another operation that related to the targeted operation but they are different.

Typically we compute, more than we intend to compute, and that allows substitution to take place.

Dating heuristic. About how many dates they have last week, and another question are they happy or not. It is uncorrelated. But you invert the order of the two questions.

An example of a focus and an illusion. That you have an emotional reaction to the question about the numbers of dates, that emotional reaction is sitting there and you ask the question no.2. You substitute one of the other. They are not confused that it were uncorrelated.

Subjective confidence is not a judgement of all, it is a feeling, from system 1, coherent story from a very little information and can be distrarous. The quality of story depends on the information stored. See the environment they have, not to trust only their confidence.