Researchers decided to pit brain-damaged patients against normal subjects in an investment game. The brain-damaged patients had normal IQs, and the regions of their brains associated with logic and cognitive reasoning were fine. The damage was in the part of the brain controlling emotions: the patients didn’t have normal experiences of fear or anxiety.
In a simple game, researchers set up 20 rounds of coin tosses. Each player started with $20. For every round, the individuals could play or sit out. If they played, they handed the experimenter $1. The experimenter flipped a coin, with a $2.50 payoff for a tails flip ($1.50 net of the dollar to play) and nothing for a heads (equivalent to a $1 loss). If they didn’t play a given round, the subjects got to keep their dollar. The goal was to end up with the most money possible.
The game is not hard to figure out. Since for each round the expected value is higher to invest than not to invest ($1.25 versus $1.00), the best strategy is to invest in every round.
So who did better, the brain-damaged or normal subjects? It wasn’t close. The brain-damaged patients ended up with about 13 percent more money than the normal patients ($25.70 versus $22.80). Why? The braindamaged patients participated in 45 percent more rounds than the normal players.
Even though the normal subjects intellectually knew what to do, loss aversion took over. Researcher Baba Shiv comments, “they know the right thing to do is invest in every single round, but when they actually get into the game, they just start reacting to the outcomes of previous rounds.” 13 Normal participants only invested in 41 percent of rounds following a loss, less than half the rate of the brain-damaged patients.
This research raises an intriguing question: is it possible that successful investors simply have a lower loss aversion ratio than the rest of the population? And if so, how much of the difference can we attribute to hard wiring versus the culture of the investor’s firm?
None of this is to say healthy emotions are undesirable. In fact, the personal finances of the brain-damaged patients in the study were awful. Three-quarters of them had experienced bankruptcy because their riskseeking behavior led to poor decisions and their lack of emotional intelligence allowed them to get involved with some unscrupulous people.
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