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Tag "Psychology"

Its tough to deal with losses, but you must

This article of ours first appeared in Mint on 12th Feb, 2018.

Imagine you have units of ABC mutual fund. You consider switching to XYZ mutual fund, but don’t. One year passes and you find that you would have made Rs1 lakh more if you had switched to XYZ mutual fund. How would you feel? Now imagine another scenario where you have units of ABC mutual fund, and during the year you switched to XYZ mutual fund. One year passes and you find that you would have made Rs1 lakh more had you kept ABC mutual fund. How would you feel? Which condition would make you feel worse?

Studies by Nobel-winning behavioural scientist Daniel Kahneman and his colleague Amos Tversky have found that 92% of people find the second condition worse. The mistake of an action seems worse than a mistake from inaction. It generates more regret because the first condition is like an opportunity lost whereas the second condition is an actual loss. The second condition translates to seeing oneself as a loser, but not the first. The monetary loss is followed by a psychological loss from admitting you made a mistake. That’s why losses cause a lot of pain.

The region of the brain associated with evaluating negative emotions like pain and disgust is called ‘insula’. When people smell vomit or see a cockroach, the insula bursts into action. The insula also lights up when we lose money. In a study by M.P. Paulus et al, the insula was roughly three times as active after people lost money as it was after they won money. The more intensely the insula fired, the more likely the person was to pick a lower-risk option the next time.

Losing money on an investment is like smelling rotten food, it’s disgusting. We try to move away from it, wipe it off our memory and want to wash our hands off it. That explains why investors, including me, find it difficult to sell an investment when its price is down, since the notional loss will now get converted into actual loss. That makes most people like to believe that the price of the loser investment will go up one day and that’s when we’ll sell it. The thinking goes, ‘If we sell it now and it bounces back, we would have made two mistakes —one buying high and two selling low. If we hold on and it bounces back, we will feel much better.’ However, if we hold on and it doesn’t bounce back, it will be a bigger loss than had we sold it. Hanging on makes sense only if we believe that the investment has value and that value is more than the existing low price of the investment. However, that’s a tough decision which leaves most investors paralytic.

An analysis of 2 million transactions of Finnish investors by behavioural scientists Hersh Shefrin and Meir Statman, found that they are 32% less likely to sell a stock after a sharp fall in price. Professional money managers in Israel cling to their losing stocks for an average of 55 days—more than twice as long as they hold winners. A study by David Harless and Steven Peterson that looked at 97,000 trades, found that investors cashed in on 51% more of their gains than their losses, even they could have raised their average annual returns though by 3.4% points if they had held on to winners and dumped the losers. The study by Martin Weber and Colin Camerer found that among 450,000 trades in 8,000 accounts at a brokerage firm, 21.5% of clients never sold a single stock that had dropped in price. Researchers Zur Shapira and Itzhak Venezia found that new mutual fund managers sold 100% of the stocks ranked at the bottom, implying that their predecessors would have been paralyzed by their own mistakes that only a new person could clean the portfolio. Karl Case and Robert Shiller find that people trying to sell their house hold out longer when they are facing a loss, and will often take the house off the market and not sell, rather than lose money on it.

Dealing with losses is painful, but thinking about the loss differently could help. One behavioural design solution could be to find another investment that you would like to put money into. Think of the proceeds as funding the new investment by selling the loser investment. It will help you generate cash for buying the new investment and you can write off the loss to offset your capital gains and reduce your taxable income. Moreover, the learning of what went wrong should be undertaken by introspecting why the loser investment was originally bought and why its value had changed over time. If the investment still has value and potential, then holding on would make sense. If not, the faster you can sell, the lesser will be your loss.

Just two words can alter first impressions

Our propensity to label people, ideas or things based on our initial opinions of them is so high, that even two simple words have the power to influence it.

Here’s the experiment. A class of MIT students were told that their economics professor was out of town and therefore a substitute instructor would be filling in. The students received a brief bio describing him. Half the students received this version:

Mr._____ is from the Department of Economics and Social Science here at MIT. He has had three semesters of teaching experience in psychology at another college. This is his first semester teaching Economics 70. He is 26 years old, a veteran, and married. People who know him consider him to be a very warm person, industrious, critical, practical, and determined.

The second half received the same bio. Only two words had been changed:

Mr._____ is from the Department of Economics and Social Science here at MIT. He has had three semesters of teaching experience in psychology at another college. This is his first semester teaching Economics 70. He is 26 years old, a veteran, and married. People who know him consider him to be a rather cold person, industrious, critical, practical, and determined.

At the end of the class, each student filled out an identical questionnaire about the substitute instructor. Most students from the first group that received the bio describing him as ‘very warm’, loved him. They described him as good natured, considerate, informal, sociable, popular, humorous and humane. Though the students in the second group sat in the same class, same session, most of these students saw him as self-centered, formal, unsociable, unpopular, irritable, humorless and ruthless!

Just two words have the power to alter our perception of another person and possibly sour the relationship before it even begins. Once we get a label in mind, we don’t notice things that don’t fit within the category. Labeling is important for us to go though the regular day bombarded with information, so that we can organize and simplify. But it also prevents us from seeing things as they are.

No wonder in job interviews, we all put our best show, and not surprisingly we just can’t see the realities of candidates. So while accessing anything look for objective data. From another point of view first impressions matter, so position yourself, your company, your brand to gain that advantage.

Source: Harold Kelley (University of Michigan) – The warm-cold variable in first impression of persons, Journal of Personality 18, no 4 (1950): 431-439.

Ek baar jo maine commitment kar di, toh phir main khudki bhi nahi sunta   (Once I commit, then I don’t even listen to myself)

Its a famous dialogue of movie star Salman Khan in the Bollywood movie -Dabang.

I’m sure we’ve all experienced doing things over and over again that one day we realize it’s difficult to do it any other way. Whether we’ve invested our time and money in a particular project or poured our energy into a doomed relationship, it’s difficult to let go, even when things aren’t clearly working.

You may say that commitment is essential to motivation. Sure it is. But sometimes it works in funny ways. Take for example, Max Bazerman’s negotiation class at Harvard Business School. In his class he waves a $20 in the air and offers it up for auction. Two rules: bids are to be made in increments of $1 and runner-up losses his/her amount bid. It means that the second best finishes last and has to honor his/her bid, while receiving nothing in return. Winner of course wins the $20.

The bidding starts fast and furious until it reaches $12 to $16 range. When students realize they’re approaching the $20 mark, everyone drops out, till the two highest bidders are left.

Without realizing it, the two students with the highest bids get locked in. Neither wants to be the loser who pays money for nothing. So they become committed to the strategy of playing not to lose. It’s like both saying to themselves ‘Ek baar jo maine commitment kar di, toh phir main khudki bhi nahi sunta’.

The auction continues with the bid going up $18, $19 and yes $20. The other students begin thinking about the poor classmate who bid $19. But when the bidding continues to $21, $22, $23 the students cannot control their laughter. It’s common sense for the bidder to accept his/her loss and stop the auction. But apparently it’s easier said than done. The momentum and the looming loss pull the two bidders. To withdraw is to accept a sure loss, which is highly unattractive. So the bidding continues $50, $100, $150. Max Bazerman says up to a record $204.

The two combined forces at work – loss aversion and commitment – make us behave irrationally. And these two forces affect a lot of decisions of ours – whether its love, career, business, shopping, travel, etc.

Apparently, Max Bazerman also performs a $100 version of the auction for executives. This auction goes up in $5 increments. But the higher stakes don’t prevent enthusiastic bidding.

Source: Judgement in Managerial Decision Making (John Wiley & Sons 2002, page 79-80) – Max Bazerman – who in turn got the idea from Martin Shubik’s The Dollar Auction Game: A paradox in Noncooperative Behavior & Escalation – Journal of Conflict Resolution 15 (1971): 109-111.

Do movie reviews really have an impact on us?

Though each one of our tastes vary, there are a couple of common factors that help us decide whether we should watch the latest movie getting released – cast, director, producer, writer, music including the item song (we’re referring to Bollywood), the vibe of the promotional video, posters, interviews, etc. But what about the movie’s reviews? Do you feel it really has any impact on whether you decide to watch the movie or not? And whether you end up liking the movie or not?

Let’s try and understand this phenomenon via an interesting experiment done by Dan Ariely, Baba Shiv and Ziv Carmon. In this experiment they used a beverage that claims to increase mental acuity – SoBe and developed a 30 min word jumble test. The first group of students took the test without drinking any SoBe. The second group was told about the intelligence enhancing properties of SoBe. These students were charged $2.89 for the SoBe. A third group was exactly like the second group, but were told they would be given a discount on SoBe and would be charged only 89 cents.

The group that drank the full charge SoBe performed slightly better than the group that didn’t drink SoBe. And the group that drank the discounted SoBe performed worse than the full charge SoBe group and the SoBe-free group. The value the students attributed to the SoBe made the difference in their scores. Says Dan Ariely, one of the researchers and author of Predictably Irrational, “Expectations change the reality we live in. When you get something at a discount, the positive expectations don’t kick in as strongly. And once we attribute a certain value to something, it’s very difficult to view it in any other light.”

That suggests that if we shape our view of a movie by hearing or reading the opinion of critics, then the value the critic gives, becomes our expectation and therefore reality. So if the review is good, then we’re likely to like the movie and if its bad we may decide not to see it or if we happen to see it, we’re more likely to not like it.

Now why is it that so many movies do well in India inspite of not getting good reviews? A possible explanation is that those people don’t read reviews by critics, but instead follow reviews of other like-minded people, whose tastes in turn differ vastly from the critics. Either way social proof works.

Source: Placebo Effects of Marketing Actions: Consumers May Get What They Pay For – Baba Shiv, Ziv Carmon, and Dan Ariely – Journal of Marketing Research 383 Vol. XLII, 383–393 (November 2005)

Use a calculator, not your heart, to assess risk

This article of ours first appeared in Mint on 6th Dec, 2017.

It has taken millions of years for humans to evolve into the species we are today. But it’s been only a few decades of living with rapid technological and economic development. We have lived among and survived snakes, spiders and other species that could have led to our extinction. That’s probably why our brain has developed parts like the amygdala, which acts as an alarm system, generating fast emotions like fear when we notice anything that’s out of place or scary. The amygdala that induces the fear reflex has helped our ancestors survive and it continues to remain a vital tool in today’s daily life. When we see a face that’s scared, we take cues and act instantly; or, if we smell smoke, the amygdala floods the body with fear signals even before we are consciously aware of being afraid.

However, today, life has been changed dramatically due to money and technology. A potential economic threat makes us panic. When our investments take a sudden drop, we react and sell our investments; making ourselves poorer, not richer. But we feel more comfortable to invest when markets are rising. We do the opposite of what common sense shows us—we need to buy low and sell high to make a profit, but we buy high and sell low. In other circumstances, people avoid investing in the stock markets because they are afraid that the stock market might crash, but have no idea how rising prices eat up their savings and cause a loss of money. We are not good at assessing risk—monetary and non-monetary.

The more vivid and imaginable a risk is, the scarier it feels. Behavioural scientist, Paul Slovic, says people will pay twice as much for an insurance policy that covers hospitalization for ‘any disease’ than one that covers hospitalization for ‘any reason’. Any reason covers any disease, but ‘any reason’ seems vague, while ‘any disease’ is vivid. The vividness fills us with fear. It’s not logical. Decades of behavioural science is proving than we don’t always make rational decisions. On the contrary, we often make decisions based on emotion and therefore the decisions sometimes tend to be not rational. For example, people are scared of flying because a plane crash is vivid. Tons of people, including myself, buy air travel insurance, but if we take probability of a plane crash into account, we will find the air travel insurance not worthwhile. At the same time, driving a car without wearing a seat belt feels perfectly safe for a lot of people in India. Let’s see what the numbers have to say. Last year, no one died in India due to a plane crash compared to more than 1,50,000 people who died in road accidents in 2016. So what’s safer—flying by plane or driving on roads? Here’s another example: terrorism. Terrorism creates images of violence, gun shots, bombs, bloodshed. We feel that the risk of terrorism is uncontrollable. But did you know that only 178 civilians died due to terrorism in India this year. On the other hand, smoking kills 1 million people every year in India. Yet we feel more scared of terrorists than cigarettes. But smokers feel they are in charge and understand the consequences, that’s why the risks seem lower than they truly are.

Says Nobel-winning behavioural scientist, Daniel Kahneman, “We tend to judge the probability of an event by the ease with which we can call it to our mind. The more recently an event has occurred, or the more vivid our memory of something like it in the past, the more available an event will be in our minds and the more probable it will seem to happen again.” Clearly that’s not the right way to assess risk because the event does not become more probable just because it occurred recently. In fact, the best time to ‘value invest’ is when the markets are depressed. That’s likely to be a time when there is more bad news than good news, when corporate performances don’t look that good and when analysts don’t have nice things to say. In other words: when markets are low. However, people judge such times to be risky and stay away from stock markets, and when the markets are rising, people hear positive news all around and most investors find comfort in positive statements made by analysts. Due to this positivity and euphoria, people invest at high levels only to find that the trend doesn’t hold true for long.

Understanding risk is critical to managing money. So when you think about risk, it’s better to use a calculator instead of your heart.

Potential loss can make us behave irrationally

There are many instances where a perceived loss makes us behave irrationally. Here’s one of the many stories – of Captain Jacob Van Zanten – in connection to loss aversion.

Captain Van Zanten was regarded as one of the most experienced and accomplished pilots in the world. He was head of KLM’s safety program, known for his attention to detail, methodical approach and a spotless record. He even featured in KLM’s ad which said KLM – the people who made punctuality possible.

On one flight en route from Amsterdam to Las Palmas airport in Canary Islands, Spain, Van Zanten got an urgent message that a terrorist bomb had exploded at the Las Palmas airport. He was now made to land at nearby Tenerife’s tiny airport along with many other re-directed flights.

He safely parked the plane. But he wanted to take off before the mandatory rest period got underway, because there was no replacement crew at Tenerife, the airline would have to find passengers a place to stay, the delay would initiate a cascade of flight cancellations throughout KLM and he of course had thoughts about his own reputation on line.

Two hours had already passed by. So Van Zanten decided to refuel at Tenerife thinking that he would shave an hour off the turnaround at Las Palmas. But soon thereafter, word came from Las Palmas that the airport had finally reopened. But it was too late to stop the refuel.

Finally just when it looked like he could take off, a thick layer of fog descended upon the runway – visibility dropped to just 300m. Nevertheless he revved up the engines and lurched down the runway. When the co-pilot alerted him that they didn’t get ATC clearance, he hit the brakes and asked him to get the approval. The co-pilot received the airway clearance but not the takeoff clearance. Completely out of character, Van Zanten again turned the throttle to full power and roared down the runway.

To his nightmare he saw a Pan Am 747 parked across the runway while he was approaching full speed. He managed to pull the aircraft’s nose desperately, but the underside of the fuselage ripped through the top of Pan Am. The KLM plane burst into flames killing all crew and passengers, 584 in all, including Van Zanten.

The aeronautical community was stunned. The experts concluded that it wasn’t a mechanical failure or terrorist attack. Pan Am missed a taxiway turnoff and wasn’t supposed to be on the runway. Because of the fog Van Zanten couldn’t see Pan Am. Pan Am pilot couldn’t see KLM. The under staffed tower controllers couldn’t see either. But why did a seasoned pilot, the head of safety at KLM make such a rash and irresponsible decision?

The best explanation the investigators came up with was that Van Zanten was feeling frustrated. But how could he cast aside every bit of training and protocol when the stakes were so high?

Turns out the investigators were right. We’re all susceptible to a tendency to go to great lengths to avoid possible losses. We’re loss averse. Van Zanten’s desire to avoid a delay started small. But as the delay grew longer, the potential loss seemed almost inevitable. He got so focused on avoiding the loss, that he tuned out of his common sense and years of training.

As Columbia business school professor, Eric Johnson says, “the more meaningful a potential loss is, the more loss averse we become. In other words, the more there is on line, the easier it is to get swept into an irrational decision.”

Source

Employee performance and happiness talk (Gartner)

Our latest talk was on applying behavioural science for improving employee performance and happiness at the Gartner Symposium ITXPO, Goa for India’s Top 300 CIOs.

Behavioural science experiments on employee performance and happiness show that businesses often operate in ways that are not aligned to principles of human psychology, leading to engagement and motivation levels that are disappointing.

For example, when performance appraisals are done annually, employees are also given feedback on improvement and learning. But behavioural science shows that the focus of employees at that stage is on earning, while learning shuts down. Companies can benefit to a great extent if the ‘scope of improvement’ conversation is done as a separate exercise at a separate time than the performance review and appraisal.

The talk covered behavioural science findings on rewards, recognition, incentives – monetary, non-monetary, experiential; performance appraisal, feedback, teams, collaboration, workplace design, change management, productivity, culture and core values.

Like we always do, the talk focussed on simple but innovative and practical Behavioural Design nudges that could make a big difference in employee performance and happiness.

 

How a teacher changed lives of school kids

Her name is Molly Howard, a teacher who taught at a school in Georgia, US, where 80% of the kids lived in poverty and only 15% of the kids went on to study in colleges. Many teachers had a defeatist attitude – some children can and some children can’t.

But Molly challenged that view. Once she joined she abolished the school’s two-track system that separated the college bound students from the vocational students. She beefed up assessments and tutorial programs. She matched students with teachers who would be their on-campus advisors. But the biggest impact came from how she graded the students – A, B, C and Not Yet. No D-F.

In her view the students had accepted a culture of failure. These students didn’t used to do their homework or turned in shoddy work. They behaved as though they were complete failures. Getting a D or F seemed to be an easy way out for not trying enough.

In her new system of ‘Not Yet’ if the students did substandard work the teachers were made to say ‘Not Yet’. The students said to themselves, “My teacher thinks I could do better.”

Molly Howard had transformed her students with a simple Behavioural Design nudge. Test scores went up. The graduation rate increased dramatically. Howard was given the U.S. Principal of the year award in 2008.

Let’s not give up on North Korea, not yet.

What it takes to be an innovator

Most of us tend to think that innovators are born geniuses. It’s in their blood. Either you have it or you don’t. But reality is anything but that. Innovation like anything else is a habit that can be designed. Just the way a company called Brasilata has done.

Brasilata is a US$ 170 million manufacturing firm from Brazil that makes various kinds of steel cans. Manufacturing may seem boring but Brasilata is one of the most innovating companies in Latin America. For example in 2012, employees submitted 1,71,916 ideas – an average of 170.4 ideas per employee! Many of the suggestions led to the development of new products. The decision regarding approval and implementation of these ideas is made most of the time by the front line.

For instance, Brasilata came up with a new approach for steel cans designed to carry flammable liquids to meet UN standards. These cans needed to withstand a drop from 4 feet. Most manufacturers did this by thickening the metal layers, which ended up using more raw material. But Brasilata’s employees created a new steel can inspired by car bumpers that collapse on impact. The new steel can be deformed on impact, reducing stress on critical seam. This also reduced the amount of steel used.

In another instance, when the Brazil government rationed energy in 2001 due to severe energy crisis, Brasilata’s employees reduced its energy consumption by 35% and even resold extra energy saved to other companies.

Innovation is so embedded in the employees that two employees came up with a suggestion of eliminating their own jobs! Beat that.

Is innovation in their blood? Are they born with it or has been it designed?

Let’s see what their founders put in place for this to happen. To begin with the employees are called ‘inventors’. It isn’t simply feel good language. When they join the company they are asked to sign an innovation contract. It challenges them to come up with ideas for better products, improve production processes and squeeze costs out of the system. Procedures have been made for them to submit their ideas. Brasilata distributes 15% of its net profits amongst its inventors.

I have no doubt that the journey would have been a difficult one. It probably took a while for employees to become good at inventing. And initially employees might have even felt like imposters with themselves being called inventors. The founders would have created an expectation of failure – not the failure of the mission, but of failure on route.

And yes I forgot to mention that the idea of the two employees of eliminating their job was accepted. Their explanation was that they had eliminated their job positions to increase company profitability and this would in turn be distributed to all; as mentioned previously 15% of Brasilata net profits are shared by the employees. But the two were placed in a new roles because Brasilata has a no dismissal policy. In the opinion of the chief executive officer “job security functions as a safety net which enables the trapeze artist to perform to his best ability without risking his life.”

Source: Brasilata

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