When Intuition is Wrong.

When was the last time you used your gut-feeling to make a decision?  In my experience, people often use their intuition to make financial decisions.  I have been told many times by someone that they just have a feeling the market is about to crash or they have a good feeling about this one particular stock. 

I have no doubt that intuition can serve as a powerful force in some people’s lives, and that some people are more in-tune with it than others.  But should we trust our intuition when it comes to money?

Probably not.

I have finally started reading Daniel Kahneman’s book ‘Thinking Fast and Slow’.  It’s not exactly what you might call an ‘easy-read’ but it’s a fascinating insight into how our mind plays tricks on us.

Here’s a puzzle from his book.  “Do not try to solve this puzzle, but listen instead to your intuition.”

               A bat and ball cost $1.10.

               The bat costs one dollar more than the ball.

               How much does the ball cost?

“A number came to your mind.  The number, of course, is 10: 10 cents.  The distinctive mark of this easy puzzle is that it evokes an answer that is intuitive, appealing, and wrong.”

Now work through this problem.  You will see that the answer is not 10 cents.  If the ball did cost 10 cents then the bat must cost $1.10, and the cost together would be $1.20.  For the bat and ball together to cost $1.10, the ball must cost 5 cents.

I find this puzzle incredible.  Such simple maths and yet it’s so easy to come up with the wrong answer.

Many people are overconfident, prone to place too much faith in their intuitions.  They apparently find cognitive effort at least mildly unpleasant and avoid it as much as possible.
— Daniel Kahneman

The traditional definition of intuition is “knowing without knowing how you know”.  This is not an accurate definition according to Kahneman, as it assumes that you do in fact know.  A better definition would be that “intuition is thinking that you know without knowing why you do.”  With this definition we accept that our intuition can be right or wrong.

Shane Parrish wrote in a post on Farnam Street Blog that our intuition is more likely to be right if three conditions are met:

1)      The environment is unchanging or slow to change. Complex adaptive systems are poor places to develop intuition.

2)     We have a large sample size. That is, we get a lot of practice.

3)     We receive immediate and accurate feedback.

Playing chess is an example of where you can build on intuition because all three conditions can be met. 


When it comes to money, and the stock market in particular, these three conditions are probably not met. 

The stock market is constantly changing and most people don’t get a chance to have a lot of practice and the feedback is not immediate.

There are other areas of life where our intuition might lead us down the wrong path.  Dan Ariely, another Behavioural Economist, recently talked about this on a podcast with Ted Seides

When Dan was 18 he was badly burned – third-degree burns over 70 percent of his body.  He spent three years in hospital.  His story is amazing. “Life in hospital gets you to think about lots of things.  For me, the beginning was mostly thinking about how to minimize the pain from bandage removal.”  The nurses had a method and a theory – rip the bandages off quickly to minimize the duration of the pain.  Intuitively, it makes sense.  Ariely hated it.  He was sure the nurses had it wrong. 

When he left hospital he researched and studied pain.  What he discovered was that maximizing the momentary pain is absolutely the worse way to remove bandages for burn patients.  If pain goes on for longer, you don’t actually remember it as any worse.  However, if you increase the intensity of the pain, you can make it much worse. 

Ariely’s curiosity took him into some other fascinating study areas where reality is very different from what we intuitively think. 

He has spent recent years looking at human motivation in the work environment.  What is it that incentivizes people to work hard, over and above what they need to do in order to keep a job?  Ariely calls this goodwill - the gap between the minimum effort an employee makes to keep their job, and the effort they make when they are fully engaged. 

Monetary rewards are the most common form of incentivization – pay people more, give them a bonus, and suddenly, like magic, they will work harder.

But do they actually?  How motivated are we by money?

Not that motivated, it turns out.

Ariely tells the story of working with Intel.  Intel’s employees in the chip manufacturing facilities work four days on, four days off.  Management was concerned that people were coming back from their four days off unmotivated and wanted an incentive to have them hitting the ground running on that first day back.  They started a program that enabled employees to earn a $30 bonus if they produced 1300 chips in their first day of work. 

Ariely came in and looked at this policy.  He divided the employees into four groups.  Group 1 was the control – there was no incentive.  Group 2 got the $30 bonus.  Group 3 got given a voucher for pizza and group 4 received a congratulatory text message from the boss.  The groups knew ahead of time which incentive they would receive (if at all) for producing 1300 chips on day one.

The results are amazing!  Ariely found that all three incentive groups did better than the control on day one.  Any incentive seemed to work.  But it was what happened after day one that mattered.  The employees that received the cash bonus increased productivity by 6% on day one, but productivity reduced by 12% on day two.  Ariely found that over the four days, Intel were losing 5-6% of productivity in the group receiving the cash bonus versus the control group.  AND it was costing them cash!  The incentive totally backfired.

The group receiving the compliment from the boss did the best – productivity increased in day one and then slowly reduced after that, but it never backfired.

How we are treated at work seems to be more important that how much we are paid. Aren’t humans fascinating? 

Anecdotally I see this to be true in others and certainly true in my own experience.  I worked in a company that was opaque, where I viewed the practices as unfair, and there was no trust – a tripling of the salary wouldn’t have made me stay.

I have always believed that people just want to be trusted, cared for and appreciated, and I have repeatedly wondered why this is so often overlooked by business leaders.  Maybe the further up we get, the more we lose a sense of what matters in real human terms.  ‘It’s just not about the money’ are words that I have heard uttered many times. 

I have digressed here, but Ariely’s research and data show how important it is to look after your employees and make human capital an investment and not a cost. 

I often talk about how counter-intuitive investing and money is.  What we most want to do with our money is almost always the exact opposite of what we most need to do in any particular moment in time.  This research into intuition and motivation by Kahneman and Ariely in particular is another example of how we need data and research to frame the decisions we make around our money. 

We also need to address how we use corporate capital as it’s obvious from Ariely’s work that many leaders are getting big business decisions wrong by misunderstanding human psychology and the importance of it as a driver of growth over the long term. 

If you are in a business leader, owner or HR executive, I highly recommend you take an hour or so to listen to Ariely’s conversation with Ted Seides. Then drop me a line and let me know what you think.