In certain circles, the University of Chicago’s Richard Thaler was already a pretty big name. Last month, his circle widened further when he became the latest recipient of a Nobel Prize in Economics, “for his contributions to behavioural economics.”
While there may be no more indelible stamp of approval than a Nobel Prize, Thaler is an interesting pick. As author Michael Lewis described in a 2015 Bloomberg column, “For a surprisingly long time behavioural economics wasn’t much more than a bunch of weird observations made by Richard Thaler, more or less to himself.”
Most of Thaler’s work explores how susceptible we are to inconsistent behaviour, based on how choices are presented to us. For example, he found people will more readily agree to a medical procedure if they’re told they have a 95% chance of living, than if they’re told they have a 5% chance of dying. And people will drive farther to save $10 on a $45 purchase than on a $495 one.
Rational? Not really. Even though we can all do the simple math on either of these scenarios, we display weird behaviours anyway. Which brings us to a pertinent question: How does evidence-based investing and behavioural economics come together … or do they?
The University of Chicago Booth School of Business has championed both lines of inquiry, so that suggests some connections. Those who debate otherwise don’t usually question whether behavioural biases exist, but whether they require separate study. As Lewis explains, “In the early 1970s, when Thaler was a student, his professors didn’t argue that human beings were perfectly rational. They argued that human irrationality didn’t matter, for the purpose of economic theory, because it wasn’t systematic.”
As Thaler’s career has unfolded over the decades, he and his colleagues have demonstrated that our financial behaviours, while often irrational, are also often quite predictable; i.e., they seem to be systematic after all, according to time-tested, peer-reviewed, academic evidence.
Thus my take is that it takes two to tango in our financial markets. It’s important to manage your investment portfolio according to an evidence-based understanding of how efficient markets operate. But to make best use of those largely efficient markets, it’s equally important to manage your own behavioural biases, with academic evidence once again as your guide.
So, do we follow Nobel laureate Eugene Fama’s evidence-based investment theory or Nobel laureate Richard Thaler’s investor behaviour insights? Yes, to both … which is why I’ve long covered both in my blog.