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Page last updated at 11:28 GMT, Monday, 23 February 2009

Decision time

Traders making decisions
Even professional investors can struggle to make decisions

Standing at a personal or professional crossroads, do you try to think rationally or go by gut feeling. It might be time to start thinking about the way you think, writes Jonah Lehrer.

Ever since Plato, humans have thought of ourselves as rational creatures.

When we make a decision, we are supposed to consciously analyse the alternatives and carefully weigh the pros and cons. This simple idea underlies the philosophy of Plato and Descartes, forms the foundation of modern economics and drove decades of research in cognitive science.

Elliot endlessly deliberated over irrelevant details, like whether to use a blue or black pen, or what radio station to listen to, or where to park his car

Over time, our rationality came to define us. It was, simply put, what made us human.

There's only one problem with this assumption of rationality - it's wrong. It's not how our minds actually work. For the first time in human history, we can look inside our brain and see how we think.

It turns out that we weren't engineered to be rational or logical or even particularly deliberate. Instead, our mind holds a messy network of different areas, many of which are involved with the production of emotion.

Whenever we make a decision, the brain is awash in feeling, driven by its inexplicable passions. Even when we try to be reasonable and restrained, these emotional impulses secretly influence our judgement.

Pathological indecision

Some of the first evidence for this theory came from the work of the neurologist Antonio Damasio. In the early 1980s, Damasio began studying a patient named Elliot who, after a brain tumour, lost the ability to experience any emotion at all.

At the time, scientists assumed that our emotions were irrational. A person without any emotions - in other words someone like Elliot - should make better decisions.

If you think too much about buying something you may buy a lemon

But that isn't what happened to Elliot. Instead, his tumour left him with a devastating disorder - he was pathologically indecisive. Routine tasks that should have taken ten minutes now required several hours.

Elliot endlessly deliberated over irrelevant details, like whether to use a blue or black pen, or what radio station to listen to, or where to park his car.

When choosing where to eat lunch, Elliot would carefully consider the restaurant's menu, seating plan, and lighting scheme. He would then drive to each restaurant to see how busy it was.

But all this analysis was for naught. Elliot still didn't know what to do. Pure reason is a disease.

And yet, this doesn't mean that we should always trust our emotions. Although our gut feelings can often be astonishingly wise, they can also lead us to make a consistent set of decision-making mistakes.

Emotional flaws

When we eat too much food, or spend too much money on our credit card, or make bad investment decisions, it's probably because we're listening to our emotional brain, when we should really be thinking rationally.

When our emotions get out of control - and there are certain things that reliably make this happen - the result can be just as devastating as having no emotions at all.

You can't avoid loss aversion unless you know that the mind treats losses differently than gains

In recent years, psychologists and neuroscientists have identified a long list of these emotional flaws that regularly lead us astray.

Consider a mistake known as loss aversion, which was first identified by the psychologists Daniel Kahneman and Amos Tversky.

The psychologists noticed that, when people were offered a gamble on the toss of a coin in which they might lose $20, they demanded an average payoff of at least $40 if they won.

The pain of a loss was approximately twice as potent as the pleasure generated by a gain. Furthermore, our decisions seemed to be determined by these feelings. As Kahneman and Tversky put it: "In human decision-making, losses loom larger than gains."

Loss aversion is now recognised as an important mental bias, with widespread implications. Our desire to avoid anything that smacks of a loss often shapes our behaviour, leading us to do foolish things.

Losing shares

Look, for example, at the stock market. When investors evaluate their stock portfolio, studies show that they are most likely to sell stocks that have increased in value.

Unfortunately, this means that they end up holding on to their depreciating stocks. Over the long term, this strategy is exceedingly foolish, since it ultimately leads to a portfolio composed entirely of shares that are losing money. (A study by Terrance Odean, an economist at the University of California, Berkeley, found that the stocks investors sold outperformed the stocks they didn't sell by 3.4%).

Swiss Army Knife
The mind is like a Swiss Army Knife, full of mental tools

Even professional money managers are vulnerable to this bias, and tend to hold losing stocks twice as long as winning stocks. Why do investors do this? Because they are afraid to take a loss - it feels bad - and selling shares that have decreased in value makes the loss tangible.

We try to postpone the pain for as long as possible. The end result is more losses.

So how should we make a decision? The key is something called metacognition, or thinking about thinking.

Because the mind is like a Swiss Army knife - it's stuffed full of different mental tools, each of which is well-suited to a specific situation - it's essential that we learn how to adjust our thought process to the task at hand.

It doesn't matter if we're choosing between mutual funds or political candidates. We might be playing poker or football. The best way to make sure that you are using your brain properly is to study your brain at work.

Why is thinking about thinking so important? First, it helps us avoid stupid errors. You can't avoid loss aversion unless you know that the mind treats losses differently than gains. And you'll probably think too much about buying a house unless you know that such a strategy will lead you to buy the property.

The mind is full of flaws, but we can outsmart them. There is no secret recipe for decision-making. But learning about how we think can help us think better.

Jonah Lehrer is the author of The Decisive Moment: How the Brain Makes Up Its Mind.

Send us your comments using the form below.

This reminds me of my favourite decision-making process. I toss a coin. However, it's not the result of the coin that I'm looking at; I base my ultimate decision on my reaction to that outcome. If the coin tells me to do one thing, I might be happy that that's the outcome, in which case I go with what the coin says. If however, I get a little sinking feeling at the outcome of the coin, then I know to go with the other choice, even if it's not what the coin says. This way, I really know that I'm making the right decision; it's helped me out countless times.
George, London UK

"So how should we make a decision? The key is something called metacognition, or thinking about thinking."

Except, of course, that the process with which we are thinking about thinking must (by definition) share the irrationality of the thinking it's thinking about, rendering the "meta" rather meaningless. The only way such a metacognition would be possible would be through an analysis by a non-human agent (a robot or alien, for example), in which case the resulting analysis would be highly unlikely to be either intelligible or acceptable to us.
Dan, Oxford

I don't think you can describe Elliot as being rational; a rational being would still make decisions according to some internal penalty function (just one more susceptible to analysis than those the rest of us use) - it seems pretty clear that Elliot was unable to construct any internal penalty function whatsoever.

If loss aversion ruled human behaviour there'd be no suicide bombers, (and no soldiers of any kind), no adulterers, no gamblers, no victims of Ponzi schemes and indeed no Ponzis to scam them. In all of humanity's most irrational decisions, the losses would appear to be irrationally discounted, not irrationally amplified - the MMR scare is about the only counterexample supporting the idea of loss aversion that I am able to think of.
Ian Kemmish, Biggleswade, UK

I once bought some shares that went up ten fold, and I watched, hypnotised, as they went back down to the price I paid. I did not lose money, but could not bring myself to sell when they fell by 30% from their peak, even though I had 'decided' in advance to do this.
Michael Gover, Sheffield

I was going to comment but could not decide what to say.
Timesman, Worcs

Not true. Many investment managers keep certain shareholdings not because they're trying to 'postpone the pain of taking a loss', but rather because they feel the holding will turn around in the years to come. Investment management is, after all, primarily about investing in companies/holdings for the longer term; anything else and you may as well be a day trader.
Jill, Oxford, Oxfordshire

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