Interview with Dan Ariely: Investing in the Irrational

0:05So when we collect data on what it is that companies create in their employees and employees feel about the company that make a dent in alpha in stock market return, it ends up having nothing to do with extrinsic motivation.

0:21Rich Lumelleau:That was Dan Ariely, Professor of Behavioral Economics at Duke University. I'm Motley Fool, producer Matt Greer. Now, we've had the opportunity to interview Dan Ariely a number of times over the years. He's really great at helping us understand our behavior as investors. Motley Fool contributor Rich Lumelo recently talked with Ariely about investing, including the rational and the irrational. Welcome to Motley Fool Conversations. I'm your host, Motley Fool contributor Rich Lumelo. Today on the show, I'm thrilled to welcome Dan Ariely, a renowned behavioral economist, professor, author, and entrepreneur whose work has reshaped how we think about decision-making, money, motivation, and human nature.

1:06Rich Lumelleau:Dan's the author of 10 books, including three New York Times bestsellers like Predictably Irrational, The Honest Truth About Dishonesty, and Dollars and Cents. He's delivered some of the most watched TED Talks of all times. He penned a popular Wall Street Journal column for over a decade, and he co-founded multiple companies that apply behavioral science in health and finance and technology. Today, we'll dive into what really kind of drives our financial behavior, why we often get investing wrong, and how we can make smarter choices in an irrational world. Dan, welcome to the podcast. Lovely to be here.

1:42Thanks for the lovely introduction. I've been on podcasts from The Motley Fool a few times, and every time it was fun. So I'm looking forward to this. Excellent.

1:50Rich Lumelleau:Well, clearly, as, you know, kind of laid out in the, in the introduction, there's a lot of, a lot of ground to cover. And, and obviously, as you well know, we're, you know, an investing website. So we'll probably, you know, kind of gear things a little bit that way, but I'd love to, I'd love to, I mean, it's fascinating your, your, you know, your studies. I'd love to kind of jump into what originally drew you to study, you know, kind of human irrationality and, and maybe touch on how some of your personal experiences helped shape that journey. Yeah. So, and the people who are watching us, it's obvious that I have a very funny looking face.

2:26The people who are listening to us, you can't tell. I have half a beard and there are multiple reasons for the half a beard, but the simplest one is that I have scars on most of my body, including the right side of my face. So I just don't have hair growing on this side. And many years ago, I was badly burned. 70 % of my body, three years in hospital. And hospital really gave me kind of a magnifying glass on a few topics in society, pain, control, but also relationships, end of life. And that started my journey into trying to figure out what do we understand and are we really doing our best to provide with the best possible outcomes for our patients or customers, whoever it is.

3:24And basically what I learned was that there are lots of people with good intentions, but not enough knowledge. And as a consequence, they think they're doing what's right for their patients or customers, but they're not. In my case, one example for this was the nurses who thought that ripping off bandages quickly was the best thing for their patients, but it wasn't. And there are many other examples like this. So I'm really kind of a social engineer at heart. I look at the world and I say, what are the topics, what are the areas that I don't like human behavior, that I think we could perform much better?

4:05And then I say, and do I have the tools as a social scientist to look into this and find out are we really not performing as much as we could? And do I have the tools to try and fix it? So take a problem like hate. We certainly have too much hate in the world. I wish we had less. I know it's a big problem. I look at it and I say, but you know what? I don't know what to do. The solutions we have to hate are not relevant. It's very hard to implement them. So I don't know what to do yet. You look at misinformation. You say, okay, topic also big, important, and so on. I understand it a little bit better.

4:43You look at questions about financial decision-making easier. You look at questions about taking care of our health, not as easy as money, but still possible, and so on. So I basically kind of scout the world for problems that I think are big, places where we underperform, and places where I think that social science has some lessons of how to do things better.

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6:11Rich Lumelleau:ships right to your door and you can cancel anytime. Right now, Rhythm is offering our listeners 15 % off for your first month and free shipping at rhythm.com slash fool. That's rhythm with one H-R-Y-T-H-M health.com slash fool for 15 % off your first month and free shipping. Stop guesting, start testing rhythmhealth.com slash fool. And in your various books and TED Talks and your column in the journal, What do you think is the biggest single misconception that people have about how they make financial decisions or the thinking that goes into financial decisions? So I would say more generally that emotions are a real obstacle for good long term decisions.

6:56Now, emotions have their role. You want to fall in love. You want to enjoy poetry. You want to go to a museum and enjoy a piece of art. So it's not as if I think we should eliminate emotions, but there are topics where emotions don't help us. Emotions are not designed for long-term consequences, right? And if you look at financial investing, that's one of the areas where emotions just derail us every time. So that will be one. and then I think the second thing is that we we don't have a real grasp of compound interest and I'll give you kind of a story about this I I think of the human mind as a vintage Swiss army knife and let me let me tell you what I mean and there are two parts of this the vintage and the Swiss army knife let's start with the Swiss army knife the Swiss army knife as a metaphor is not particularly good at anything.

7:57There's not a single task that comes to your mind. Oh, I want to open a can. I want a screwdriver. Oh, the solution? The Swiss Army knife. No, no, no. It's not that good at anything. Its greatness is that it's kind of okay in lots of things, and we can easily carry it with us. And our brain as a decision-making mechanism is kind of like that. Not particularly great at anything, quite good in lots of things, and we can carry it with us. That's the benefit. But the metaphor is calling for a vintage Swiss army knife. And what I mean by that is that our brain as a decision-making mechanism developed a long time ago for a very different environment.

8:40So, you know, we have a tool to deal with snakes. And we have a tool to deal with hunger and social pressure and trust and betrayal and all kinds of things like that. we don't have a tool to deal with compound interest. So here we are with this vintage Swiss army knife in an environment that requires very different tools. We don't have something to deal with credit cards and mortgages and student loans and compound interest and so on. And what it means is that the environment, if the environment wants us to perform better, we need better tools. In the same way that in the physical world, we don't say to people, manage.

9:29We say, oh, you're not comfortable standing for a long time? Here's a chair. You can't travel great distances. Here's a bicycle. We build things to take our frail human body and make it work for us in the physical world. In the mental world, it's the same thing. Say, oh, you can't calculate compound interest. Let's help you. Let's give you a tool that does this for you. Instead, we don't do that. Instead, we don't help people make better decisions. I think that once we understand how likely we are to fail in the mental world, as we fail in the physical world, that we're frail and sensitive and so on, then we can start building better tools.

10:13I think that's kind of the hope. The hope is to build better tools for this. So emotions derail us. Things like having to think about compound interest derail us. We get very much committed to our past choices. You know, again, it's a good thing. You marry somebody. You don't want to wake up every morning and say, did I make the right choice? You buy a stock. You do want to wake up every morning and ask, did I buy the right stock? But we end up becoming very committed to past decisions we've made, even though they're not in our interest. We don't understand diversification. By the way, the stock market helps us because there are ETFs and mutual funds and so on that helps us diversify to some degree, but we don't intuitively understand diversification.

11:11diversification. One of my colleagues at Duke teaches finance, and after the 2007-2008 crisis, he told me that quite a few of his students went into banking, Lehman Brothers, and they called him afterward and told him that almost all their stock, all their fortune was in the company's stock. And he said, I taught you for a whole semester. The number one topic is diversify. And diversification says, don't invest in the companies that your human capital is involved in. That's not the right approach, not to mention not too much of... You said it's kind of amazing. Smart people who went to work in banking fail to understand diversification.

11:59It's just very much not in our tool set. Our tool set is to say, I know about this. I trust. By the way, if we live in a society, what do you want people? To trust too much or to trust not enough? The answer is you want to trust too much because eventually if people trust too much, it helps. So we have all of these tools that we carry with us that says trust the people you're with. Not necessarily good. So I would say if you ask me, what are the challenges? It's about emotion getting in the way, not understanding compound interest, not understanding the role of diversification, committing too much to our own choices and staying with them for too long.

12:49Those will probably be the basic.

12:51Rich Lumelleau:Yeah. Trading at Schwab is now powered by Ameritrade, bringing you an expanding library of education with even more ways to sharpen your trading skills. Access new online courses, insightful webcasts, articles, engaging videos, and more, all curated just for traders. Plus, guided learning paths with content designed to fit your unique interests. No sifting to find exactly what you need so you can spend your time learning to trade brilliantly. Learn more at schwab.com slash trading. Well, and to kind of keep on the theme of looking at some of your writing, in The Upside of Irrationality, you show that irrational behaviors can sometimes benefit us.

13:33Rich Lumelleau:What would you say the positive irrationalities are in long-term investing? Like, you know, for the listener who is, you know, a long-term investor, which is what we encourage, you know, what are the positive irrationalities? Okay. I'm going to tell you something that has been kind of a big focus of interest of mine for the last eight years. Sure. So for the last eight years, I've been looking at data for how companies treat their employees, how the employees feel about the company, and what that means for the performance of the stock of that company. And I have data going back to 2006 until today, and I examine lots of things.

14:10And what we find is that some elements of what we call human capital make a big difference. Others don't. So you asked me, you know, how do we think about irrationality in a positive way? Human motivation is amazing. And I'll put you on the spot if it's okay.

14:30Rich Lumelleau:Sure. Think for a minute about the three things you're proudest in your life. Don't say them out loud. Think about them. How many of them were accompanied by many moments of joy? And how many of them were accompanied by more tears and agony and complexity than joy? In general, when people think about this, they say, you know, most of the things I'm proud of were not just moments of laughter, whether it was starting a new company or writing a book or having kids. Most of these things were difficult and complex and painful. They're more like hiking Everest than sitting on the beach drinking mojitos.

15:09And all of this is just to say human motivation is incredibly irrational. We love things that are complex and difficult and challenging. We like running marathons. We like helping other people. When you really think about human motivation, you realize that it's not a rational thing. So when we collect data on what it is that companies create in their employees and employees feel about the company that make a dent in alpha in stock market return, it ends up having nothing to do with extrinsic motivation. We usually think, oh, let's pay people more. Let's give them more vacation. Let's give them better health benefits, better retirement benefit.

15:55We find zero, almost, not zero, but very, very low correlation, predictive value between those elements and stock market return. On the other hand, when you think about intrinsic motivation, all the things that are irrational, big difference. Right? So, for example, number one thing that we find is important is whether you feel appreciated. You know, from a standard economic level, it's, oh, appreciation, maybe. You know, why do you care about appreciation? Turns out appreciation is unbelievably important. Turns out I told you that salary doesn't matter. Fairness in salary matters a lot. Feeling proud about your workplace means a lot.

16:38Being connected, feeling connected to your direct manager matters a lot. So at the end of the day, what we find is that when you think about stock market returns, a lot of this market is very functional. And I take this data out and I show it to different investment managers. And they usually say, oh, you know, I want objective measures. And I say, no, you don't. I said, let's take two very important things. Let's say I want to ask you how much you love your significant other. And let's say I want to ask you in how much pain you are. I say, there's no good objective measures of those. I could wire your brain and measure your senses.

17:25Eventually, the love that you feel for your significant other, the best evidence I have is how much love do you feel right now. It's not how many emojis you send today. And the same thing is true about pain. if I want to understand your pain, it's about your subjective experience. And I say, look, human motivation is eventually about the subjective experience. If you feel that you're being treated unfairly, I don't care if all the objective measures show that you're being treated fairly. Yes, maybe it would be good for lawyers to discuss. But from a human motivation, I care what do you feel. so we started an ETF about three years ago October will have three year anniversary for the ETF and so far it looks really good and I'm very proud of it because when we started this I could have written another academic paper and I could have said human motivation here's another paper on human motivation and here's another thing but I think this is like, I hope, kind of real good evidence that companies should...

18:39First of all, it's a really good evidence. It's a good investment strategy. But it's also a really good point that companies should start looking more internally at human and human capital. And one final thing about this is I think that companies not treating human capital as an asset is an accounting mistake. And what I mean by that is when a company buys a warehouse, it's an investment. when companies invest in their people, it's a cost. That's just a mistake, right? I would want to see on the asset, on the balance sheet, how much you're investing in human capital. Anyway, and I hope we'll get there.

19:16Rich Lumelleau:Dan, Araleigh, it's been a pleasure speaking with you. For the listeners, there's a catalog of books out there, including Predictably Irrational and The Upside of Irrationality and The Honest Truth About Dishonesty and seven or eight more TED talks everywhere. It's been a real pleasure bringing you on The Motley Fool again. Thank you so much for your time. My pleasure. It was lovely. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers.

19:54Rich Lumelleau:Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For the Motley Fool Money team, I'm Pat Greer. Thanks for listening, and we will see you tomorrow.