I say this because of a recent experiment by Marie Claire Villeval at the University of Lyon. She got subjects to choose between receiving an immediate payment or a later one under various interest rates. Before the choice, however, she got some to take a sugary drink and do a test requiring mental alertness. She found that those who did so were more likely to choose the later income, especially when interest rates were high.
This tells us that people who are more alert – either because they’ve raised their blood sugar levels or because they are primed to be so by a prior mental stimulus – are more patient and price-sensitive than others. They are more likely to delay gratification and less likely to take on onerous debt. Cake and crosswords, therefore, should help us to make more responsible decisions - such as saving more – and make us more sensitive to prices.
This challenges both conventional economics and conventional financial advice (two things which are often not the same!). Both regard our rate of time preference – for future income relative to present income – as a fixed taste. But it isn’t. Ms Villeval’s research shows that it can vary according to the time of day and our mental alertness.
Of course, just because our willingness to save and postpone income varies with the time of day does not mean that it doesn’t vary from person to person too. It does, and in at least one peculiar way. Ms Villeval also found that her most intelligent subjects – the brightest students at one of France’s top universities – delayed income by more than less bright ones. This corroborates a discovery by Shane Frederick at the Massachusetts Institute of Technology, who has also found that people with higher cognitive skills are more willing to postpone income.
Insofar as more intelligent people are richer than less intelligent ones, one reason for this is simply that smarter people are more likely to save.
This isn’t necessarily because saving is the “right” thing to do, and intelligent people are more likely to see this. In Ms Villeval’s experiments there is no correct answer to the choice of when to receive income. And it is possible to save too much and to deprive oneself too much today.
However, the difference between more and less intelligent people isn’t confined to the different tendencies to delay gratification. They also differ in how they think about the stock market, as new research by Johannes Binswanger and Martin Salm of Tilburg University have found. They studied the investment behaviour of older Americans. They found a strong correlation between the likelihood of someone owning shares and their answer to the question: what probability do you attach to share prices rising over the next 12 months? No surprise here, you might think. You’d be wrong. This correlation only holds for more numerate people. Among less numerate people, there’s no such link. This is because they base investment decisions not upon formal probabilities, but upon hunches and feelings.
This doesn’t mean they are stupid or wrong (two different things); subjective probabilities can be formed irrationally, and hunches can sometimes be right. What it does mean is that we think about investments in different ways. Some use what Nobel laureate Daniel Kahneman calls “system one” thinking, which is irrational, subconscious and intuitive. Others – who tend to be more numerate - use “system two”, which is deliberative and calculating. Both have their strengths and weaknesses.
And both are incomplete descriptions of what really shapes our attitude to shares, as a new paper by Alessandro Bucciol and Luca Zarri at the University of Verona shows. They too looked at the investments of older Americans, and found something odd – that those who had suffered the death of a child were much less likely to own shares than those who hadn’t. Among 50-plus Americans who haven’t suffered such a loss, almost half own shares. But among those who have, only 30 per cent do so. This difference cannot be explained by differences in wealth or education.
Instead, there’s a ready explanation. People who have suffered a terrible misfortune are more aware of dangers than those who haven’t, and so are more averse to risk – even in areas of their life which are unrelated to their original loss.
This corroborates a finding of Ulrike Malmendier and Stefan Nagel, two California-based economists. They’ve shown that people who experienced recessions and poor equity returns in their formative years are less likely to own shares years or even decades later, whilst those who experienced inflation are less likely to own bonds.
There’s a simple message in all this. Our economic decisions – such as how much to save or whether to hold risky assets or safe ones – are not shaped merely by a conscious assessment of the outlook for the economy, market returns and interest rates. Nor – as conventional economics suggests – are differences in such decisions due merely to differences in opinions or tastes. They are also influenced by our character and intellect, by our personal life experiences, and even by our state of alertness and what we’ve eaten today.
We should, surely, at least be aware of these influences before we take big financial decisions. After all, whilst it’s impossible to know the future, we should be able to know ourselves.
