Please, not another bias!

This is the heading of a blog by Jason Collins (PhD in economics and evolutionary biology) in which he argues that the extensive list of cognitive biases listed on Wikipedia is what he sees as “the fundamental problem with behavioural economics.”

I suspect that many a recent convert to the field of behavioural economics or finance (call it what you will) may be left somewhat perplexed by that view.

But I think that Collins is fully justified in calling out what amounts to a superficial take on what the discipline has to offer. Popular belief seems to be that behavioural finance is all about rattling off a list of biases telling people in how many different ways their thinking is warped. 

Collins’ reasoning needs to be understood within the context of his background in evolutionary biology. From that perspective the assumption that we are fully rational beings is a flawed model to begin with. It then follows that there “aren’t 165 human biases. There are 165 deviations from the wrong model.”

Framing the money discussion

In spite of Collins’ criticism, there is no doubt that it is handy for a financial planner to have a sound understanding of the tenets that underlie the discipline of behavioural finance. I would further argue that the incorporation of a behavioural finance framework into one’s advice offering adds another dimension enabling a richer (no pun intended) money discussion.

But the way in which all of this is framed is absolutely crucial.

For starters, the term “bias” does not exactly have a positive connotation and telling someone that they are displaying this or that bias may cause them to become defensive instead of helping them open up for what may already be a challenging money discussion. 

Instead of using the term bias, the same point can be made by referring to the client’s unique “frame of reference”. And instead of telling the client about this or that blind spot, a lot more will be achieved by allowing clients to introspect through skillful questioning by the advisor. This, the skill to ask the right questions, is to my mind infinitely more valuable than memorising and seeking to identify all of the known behavioural biases.  

Guarding against binary thinking

The central message of behavioural finance is often understood to be that a number of heuristics (mental shortcuts) and their resulting biases cause us to be irrational, resulting in poor decision making. 

But evolutionary biologists like Collins and others like Gerd Gigerenzer have argued convincingly that these same heuristics and biases that are said to lead us astray in our financial decision making, often work very well in helping us make quick decisions in everyday situations. Indeed, without these mental shortcuts, we would be a lot less efficient.

Important to note is the fact that the thinking about humans as economic agents has evolved over time. Behavioural finance came into existence in the late 1980’s because Daniel Kahneman and Amos Tversky started questioning the rational agent model proposed by a version of ourselves known as “homo economicus”. However, the understanding that behavioural finance only seeks to show that humans are irrational is simplistic as is clear from this quote by Kahneman: “I often cringe when my work with Amos is credited with demonstrating that human choices are irrational, when in fact our research only showed that Humans are not well described by the rational agent model.”

When thinking about ourselves and our clients as economic agents, we need to be more nuanced. The fact is that we are all capable of being both – rational and irrational. Nowhere is this truth borne out more vividly than in the granting of the Nobel Prize for Economics in 2013. That year the prize was shared among three economists, two of whom were outspoken critics of each other’s work. They were Eugene Fama, father of the efficient market hypothesis who argued that markets are rational and efficient. Robert Shiller, one of the economists with whom he shared the prize, was Fama’s most influential critic. He had “assembled evidence of irrational, inefficient behavior and gained a measure of fame by predicting the fall of stock prices in 2000 as well as the housing crash that began in 2006”.

According to the Nobel prize committee, the economists had shown “that markets were moved by a mix of rational calculus and irrational behavior”. 

A measure of humility can’t hurt

Humans are wonderfully complex and the biggest contribution of behavioural finance is that it does a great job highlighting that fact. In doing so it offers infinitely more than the ever growing list of biases seeking to demonstrate yet another instance of questionable decision making. Already there are headlines pronouncing “Behavioural Economics’ latest Bias: Seeing Bias wherever it looks”. In the words of Jason Collins: “As applied behavioural scientists, we need to inject some humility in to our assessment of other people’s decisions. We need to tone down the glee we have in communicating sexy, counterintuitive experimental findings that demonstrate errors by others”.