Dan Ariely

Dear Irrational,

I am a partner in an asset management company whose purpose is to manage investments for individuals, families, and foundations.  The principles of Predictably Irrational made me think about the effectiveness of each component in our investment process.  My end in mind is: 1) to identify failure ingredients in my investment process and 2) engineer out their removal.
My question follows:

Is ‘falling in love’ with an investment hazardous to one’s financial health? Does ‘falling in love’ with an investment result in predictable behaviors (in me) that lower (or negate) what would otherwise have been an excellent investment performance?

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Dear Investor,
We have not done any research directly on this question.  Nevertheless, I suspect that the answer is that we do get attached to investments, that it is not good for us, and that it has the potential to influence our judgment for the worse.

First, regarding ‘falling in love’ with an investment; I think that we would.  What we know about the endowment (ownership) effect is that people tend to fall in love with anything they happen to own (mugs, pens, cars, kids).  Once we have something, it becomes ours and we perceive it as special. As a consequence, we value it more.  I suspect that the same could occur with investments.
On top of that, in the current economy people are feeling like they are in a losing situation (if you don’t feel this way look at your retirement account) but losses in the stock market are not psychologically realized until they are truly realized.  So in people’s desire to hold on to what they have you might suspect that in this economy there is going to be an even stronger tendency to ‘fall in love’ with an investment.
Why is this not good for us?  Because the expected value of investment options are about their future potential and the past is just water under the bridge.

The good news is that you can do something about it, and advise your clients to do the same.  Imagine that at the start of every month you don’t look at your portfolio and instead you design your strategy and market positions as if you started from scratch.  The idea is that if you start from scratch you have a clean past with no commitments to past decisions.  I am not sure if the ‘falling in love’ with an investment sentiment will go away completely but I think this way it will be less powerful.
Irrationally yours
Dan

One of the unexpected benefits of writing my book, Predictably Irrational, is the email I get from people. They discuss topics that range from raising kids to dealing with cancer to financial savings.

A few weeks ago I received an email. The sender had just finished listening to an illegal download of the audiobook and he wrote me how much he liked it. He then told me that he actually sells illegally downloaded content. But his email got even more interesting when he explained that some of the principles discussed in my book relate to his own life.For example, he described how he recently attempted to find a regular, legal job. But giving up the illegal business he had created and nurtured for five years was very difficult for him.

A second aspect of loss that he described was that of his social network of customers and friends who are linked to him through business ties. He proposed that the bond between himself and his customers is much deeper than the traditional retailer-consumer relationship. After all, in his line of illegal work the relationships have to involve more trust, reciprocity, and friendship. All of this makes it even harder to leave that circle.

This man eventually gave up his search for a legal job and went back to his life of crime. He knows his decision might lead him to prison. But he was simply unable to accept the loss of his business and social network.

The famous Economist Gary Becker proposed many years ago a model of the rational crime: Criminals would simply weigh the cost benefit of a prospective crime and act in their best interest. But as my pen pal’s story indicates, the picture is much more complex. Decisions about crime also involve our desire to avoid loss, and the need for social meaning in our life.

I suspect that if we truly want to reduce crime we have to take into account a more complete set of human motivations, including our irrational tendencies.

Dear Irrational,

Congratulations on being selected as one of Fortune’s 10 new gurus of the year.

My question to you is how do I get my son to call me more frequently?  Any advice on this?
Yours

Yoram

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Dear Aba (father in Hebrew),

I suspect that guilt could work as one of the best ways to increase phone call frequency — so I would try that first.  Also it would help if you would answer your cell phone more frequently…

Anyway, I just got home after being away for 5 days, so I will call you tomorrow.

Love

Dan