Psychologist Daniel Kahneman’s insights into dodgy decision-making and human irrationality helped revolutionise economic thinking, replacing the idea of the selfish, rational investor with something altogether more human and emotional. Once a fringe field, behavioural economics is now firmly in the mainstream, but some, like the philosopher who told Kahneman he was “not really interested in the psychology of stupidity” remain sceptical.

Are behavioural failings limited to the less bright, or are all of us prone to cognitive misadventures? Answer the questions below and see for yourself.

Quiz

(1) You are offered a certain gain of €3,000. Alternatively, you can choose an 80 per cent chance of winning €4,000, and a 20 per cent chance of receiving nothing. Choose.

Another question. Would you choose a certain loss of €3,000, or an 80 per cent chance of losing €4,000, and a 20 per cent chance of losing nothing?

(2) Is your driving above average, average or below average?

(3) Your friend notices that your lottery ticket contains her birth date and offers to trade her ticket for yours. Would you exchange it?

(4) Think of the last four digits of your phone number. Is the number of doctors in Dublin higher or lower than this number? What is your best guess as to the number of doctors in Dublin?

The

‘answers

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(1) Studies show almost all people choose the certain gain of €3,000, despite excellent odds of gaining €4,000. This caution is abandoned when it comes to the question of accepting a €3,000 loss, however, most people preferring to gamble even though it is likely to result in an even bigger loss.

We hate losses – it’s estimated the pain of a euro lost is at least twice as great as the joy of a euro gained. This instinctive loss aversion, as behavioural economists call it, results in cautious investors embracing bad gambles to try and avoid losses. Many an investor has lived to regret uttering the words, “I’ll get out when I’m even”.

How ingrained is loss aversion? Very – golfers make better putts when trying to save par compared to when they try to make a birdie; lab studies show monkeys work much harder to avoid losses than to make gains; brain scans show the fear of losing money is like the fear of physical pain.

(2) Think you’re an above-average driver? Everyone does – one study found 93 per cent of US drivers believed they were better than average.

A second study found that, of more than 2,000 people given a 10-question quiz and asked to state how confident they were in their answers, fewer than 1 per cent were not overconfident. Another asked doctors to make a diagnosis based on patient case studies – when they were 90 per cent sure they were right, their diagnosis turned out to be accurate less than 15 per cent of the time.

Some 68 per cent of analysts believe they are above average at forecasting earnings, while, at the peak of the technology bubble, nearly 90 per cent of technology company chief financial officers thought their stock was undervalued.

Market analyst and behavioural finance author James Montier notes experts are even more overconfident than lay people, with people becoming much more overconfident when they are presented with extra information – even when that information is of limited use.

When an investment fails, we curse our bad luck. When it’s a winner, we attribute it to skill. Behavioural finance expert Terrance Odeon’s studies found that overconfidence is the main reason for overtrading, concluding: “People think they know more than they do, and it costs them.”