Finance and humans: not such a great mix

During the course of my career, I’ve been lucky enough to work with a number of businesses in the financial world and a number of super smart financial professionals.

It’s always interesting and stimulating (well, almost always) but there are two abiding truths about finance and people that are striking to those – like me – who are interested in human behaviour in all contexts. On the one hand, humans are by and large not very good at finance. On the other, finance people aren’t very good at humans. 

Even the smartest of humans make lots of very obvious mistakes (largely due to the way our minds work rather than a fondness for self-sabotage): we value what we’ve got much more than the precise financial equivalent in the future; we get confused by “sunk costs” (the equivalent of MasterMind’s “I’ve started so I’ll finish”), by arbitrary chosen base-lines (Year on Year), by the way a deal is framed psychologically (is it really “an outstanding opportunity to get in on the ground floor” or just a very long shot) and we always overestimate our own contribution to success and will always found ways to allocate responsibility to other factors for our failures.

Indeed, most critically of all, at a fundamental level humans and numbers don’t mix. Even the smartest and most numerate of us fall prey to the same errors that the hoi polloi do (the breakthrough research of “Nudge Theory” founders,  Kahnemann and Tversky demonstrated that doctors and their patients are equally poor at calculating the likely outcomes of a given treatment given the same mathematical information).

Adam Kucharski’s excellent history of the development of probability and prediction in mathematics, The Perfect Bet details how mathematics and gambling have long been intertwined. Most of the most successful mathematicians who’ve built their discipline by exploring gambling games have like the rest of us, lost money gambling. The ambition to produce the perfect mathematical model of even a very simple game nearly always fails in application as well as in design. Hence, the Perfect Bet.

Equally, even the smartest of organisations and financial professionals find it very hard to understand humans – the people they work with, the people they do business with and the investors and consumers they serve. The way we tend think about how people work often diverge wildly from reality. It’s like a shadow of reality – convincing in itself but not the same thing at all. 

pic c/o http://dorotheacarney.com

The simple ideas about how normal people choose that dominate financial thinking  are pretty unrealistic. Do consumers or businesses really seek the very best option? Do they really do the math? Do they go through all of the options and create a massive spreadsheet to compare options? Or, do they fall back on shorthands like the one I bought  before, better the devil you know and the one everyone has heard of? Are people really “utility maximisers” as the economics jargon has it – looking to get the very, very best for themselves in any deal? Or, is good enough good enough?

Equally, when we think of our colleagues and collaborators, are they mere calculating machines, always seeking to max-out the numbers or are they more like real life humans? Do they simply respond to financial incentives (even if they can accurately unpick them)? Or, do other – less obviously rational – things matter almost as much? One great counterexample to the accepted wisdom is the sad fact that financial incentives to employees (bonus schemes and so on) can actually reduce performance levels and staff engagement over time.

This is a huge but important area, with lots of different disciplines arguing over the detail. Most of us don’t need to know everything but a working knowledge is always going to be helpful.

So on Tuesday 20th I’m joining the fab people at LeoCrowd to try and close the gap between how we think about people and money and what the science tells us.

I’ll synthesise the science into a simple map that you can use to think a little differently about humans and money and in doing so, I hope shed some more light on why Crowdfunding is such a popular way to raise funds for your business.

The LEOcrowd team will also be exploring the advantages of Crowdfunding as route for early stage funding for ideas, projects and businesses.

Go here to book and for more details.

See you there?