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Want to Make a Bet?

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Here’s the scenario:  Would you take a coin toss bet where you win $200 on heads and lose $100 on tails?  If you could play it twice, would that make it more or less appealing? 

 

Dr. Shlomo Benartzi and Richard Thaler, behavioural economists at the UCLA Anderson School of Management, found that coffee-shop visitors were unlikely to take the first wager and even fewer, 23% accepted the second wager.   People didn’t like the single bet, so why would they want to play it multiple times?

 

Here’s another scenario:  You have a 25% chance of winning $400, a 50% chance of winning $100 and a 25% chance of losing $200.  Would you take this gamble?  According to our economists, almost half the coffee-shop visitors took on this wager.

 

Here’s the thing:  the last scenario describes the same exact same probably as the double coin toss. 

  

According to Benartzi, people tend to consider individual bets independently, fixating on the risks for each, when they should consider the aggregate risks. 

 

This narrow framing can cause people to take on too little risk:  they might avoid the daily swings of the market and put their money in a bank account that earns almost nothing a year.  They might not take on an individual holding because they perceive that it is too risky without considering that it might be complementary to their current holdings, and therefore reduce the risk of their overall portfolio.  Or, they might fuss about one account without considering the performance of their overall portfolio. 

 

Some strategies to avoid narrow framing: 

  • If you are looking at your portfolio daily but have a multi-year time frame, you might want to look at it less often.
  • When looking at your portfolio, aggregate the assets including any work pensions.
  • If you find it very difficult to avoid stressing about one individual stock that is not performing as well, look at the fundamental reasons for holding it.If it makes sense but you still can’t stop dwelling on it, you might be better off not holding individual stocks, consider instead Exchange Traded Funds or mutual funds.

"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas." - Paul Samuelson