Bill Cutshall’s Weblog

August 26, 2008

Naive Allocation

Filed under: Intellectual Crush — billcutshall @ 5:00 am

People are epically poor decision makers.  In fact they are almost perfectly designed bad-decision-making machines.  The evidence is everywhere.  Take a look at people’s naive approach to choice allocation.

People are uncomfortable putting all their eggs in one hypothetical basket and will allocate their choices to avoid it, if possible.  Even in a situation where the consequences of being wrong are so minimal as to hardly be called consequences at all, we can see people attempting to mitigate decision risk.  I read a beautiful example the other day dealing with Trick-or-Treating children choosing which Halloween candy to put in their baskets.  When presented with a pile of Milky Ways and a pile of 3 Musketeers and told they were allowed to take two candy bars, children overwhelmingly chose one of each type.  When the same decision was structured differently and the kids were asked to choose one candy bar at each of two houses, they heavily chose the same bar twice.  Given the opportunity to diversify within a single choice, kids selected to do so even though when asked to choose twice, they showed a clear tendency towards having a preferred bar.  It turns out adults do the same thing.  When I worked in the financial services industry I saw the same phenomenon in action as people chose how to allocate investments among mutual funds in their portfolio.  Sure, the consequences were a little more real with mutual funds instead of candy bars but the principle holds true.

I wonder how often I water down my preferences in the course of a single day.

The example above is from  Nudge, a book by Richard Thaler and Cass Sunstein available at Amazon.com, where it is presented in much more interesting detail and with far greater context.  I highly recommend reading it.  It is a fascinating look inside the head of humans facing decisions.

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