By: AnnaMarie Mock, CFP®
The fascinating interplay between human decision-making and financial outcomes has long intrigued behavioral economics and psychology scholars. However, research has expanded this inquiry beyond human subjects, delving into the behavior of our primate cousins, specifically Capuchin monkeys. Situated on an island off the coast of Puerto Rico, researchers conducted an experiment seeking insights into economic behaviors, risk psychology, and the recurrence of financial crises in our societies, shedding light on the parallels between monkey behavior and human decision-making processes.
Six Capuchin monkeys sporting the moniker of James Bond characters became participants where researchers taught them to trade small metal tokens for food within a makeshift market, offering different foods at varied prices.
The researchers were curious as to whether monkeys paid attention to factors like the price of the 'goods' sold to maximize the value of the ticket.
The surprising discovery was that, with minimal training, the monkeys consistently preferred traders who offered food at lower prices, displaying a keen awareness of value exchange. At the marketplace, the monkeys had a choice of either selecting a researcher who offered two grapes per token or another researcher who presented a riskier deal of getting 1 or 3 grapes, mimicking a 50/50 chance.
This can be used in real-world examples where investors can buy shares from two companies. In one scenario, a stable, well-established company offers shares at a consistent and lower price per share. In the other scenario, there's a newer, riskier company where the price could take off or fizzle out, impacting the overall return.
Surprisingly, many investors consistently gravitate towards stable companies offering lower-priced shares. Despite the allure of the potentially higher returns promised by the riskier investment, these savvy investors recognize the value of consistency and opt for the safer bet.
An additional layer of choice and risk was added to the experiment. The monkeys were introduced to a new marketplace dynamic where they knew the potential tradeoffs of trading earlier than before. For example, the first researcher continually removed one grape from the three during the trade, where the monkeys knew they would automatically get two grapes. The second researcher would provide one or three grapes for a token without a consistent trend. The possibility of getting three grapes in either option was enticing, but the monkeys usually went to the second researcher, where the possibility of getting three grapes was greater than 0%. Although it was riskier, there was a possibility of getting a higher payout from the second researcher – three grapes.
This experiment captured the phenomenon of loss aversion, or investor's tendency to take greater risks to avoid perceived, known losses.
In essence, the pain of losing something is felt more acutely than the pleasure of gaining something of equal value. This influences decision-making across personal finance to investment strategies. For instance, individuals may hold onto declining assets in the hope of recovering losses rather than selling them, despite the rational choice being to cut losses and move on, all in the name of avoiding that dreaded loss. Understanding loss aversion provides insights into why people sometimes make certain decisions in the face of risk and uncertainty.
To mitigate loss aversion, individuals can employ several strategies. One approach involves reframing decisions to focus on potential gains rather than losses to reduce the emotional impact of perceived losses. Additionally, setting clear financial goals and maintaining a long-term perspective can help individuals resist the urge to make impulsive decisions driven by fear of loss. Diversifying investment portfolios, practicing disciplined risk management, and seeking advice from financial professionals can also aid in overcoming the detrimental effects of loss aversion.
By understanding this, individuals can navigate financial decisions with greater clarity and resilience, steering clear of the pitfalls of loss aversion and charting a course toward financial well-being.
AnnaMarie Mock is a CERTIFIED FINANCIAL PLANNER™ and Partner at HIGHLAND Financial Advisors, LLC, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management. AnnaMarie graduated from Montclair State University with a degree in finance and management and successfully passed the CFP® national exam in 2016. She has been working at Highland Financial Advisors since 2013 as a fee-only, fiduciary Wealth Advisor and is a member of NAPFA.