Wednesday, October 26, 2005

Who wants to be a millionaire?

Greed loses to caution when we have to take a chance at wealth, writes Peter Martin.

SO YOU think you want to be a millionaire? I'll let you in on an economists' dirty secret: deep down, you probably don't. Rob Fulton, of Sydney, made television history on Monday last week when he became the first person to win the top prize in the Australian version of the game show Who Wants to Be a Millionaire. But he was far from the first to be offered the opportunity.

Since 1999, nine Australians have been offered a chance to answer the million-dollar question. All nine have turned it down. Each has preferred to walk away with just $500,000 rather than risk it to aim for the big prize. As the relieved host, Eddie McGuire, exclaimed on the night: "This is the first person who's had the guts to have a go!"

It's enough to make you doubt whether Australians really are (as is commonly believed) instinctive gamblers. And enough to make you doubt whether we act as if we are (as the textbooks proclaim) profit-maximising machines...

It's a caution common throughout the world.

The British economist Ian Walker and two colleagues examined the behaviour of British contestants in a study entitled "Who Really Wants to be a Millionaire?" They presented their findings to the World Congress of the Econometric Society in August.

They found that most of the 500 or so contestants they studied didn't want to be millionaires at all. Two-thirds quit while they were ahead. And almost everyone who reached £125,000 (about $300,000) quit.

It is an important finding. Economists are not usually able to directly observe how we act when we are offered a really big gamble.

They know that we are notoriously and unreasonably cautious when we are offered small gambles. If I offer you a 50-50 bet: heads you win $200; tails you lose $150 - the odds are you will not accept, even though mathematically the offer is skewed in your favour. We are even cautious when the gambles are tiny.

Stanford University economist Baba Shiv and a team from Iowa University recently gave a roomful of Iowa residents $US20 each and offered them 20 chances to bet with it on the toss of a coin, risking $US1 each time. More was to be won each time if the coin came up heads than would be lost if it came up tails. It made financial sense to accept the bet on every occasion it was offered. And yet the Iowa residents typically accepted only about half of the time.

Then the researchers did something bizarre. They performed the same test on a group of Iowa residents who had either suffered a stroke or survived brain surgery. What they had in common was a damaged prefrontal cortex, the part of the brain that processes emotions.

These brain-damaged individuals turned out to be much better investors than the Iowa residents with brains intact. Given $US20 each and the same 20 chances to accept the attractive bet, they accepted more than 80 per cent of the time. They typically made $US3 more than did their counterparts with undamaged brains.

When the study was published in the journal Psychological Science in June the newspaper reports were sensational. One headline asked: "Are successful investors emotionally brain damaged?" Another declared: "Psychos best investors".

The importance of the team's finding is not that brain-damaged people make more sensible decisions. In many instances they do not. (Several of the volunteers with brain damage used in the study were bankrupt.) It is that the thing that holds many of us back from taking worthwhile financial risks is an emotion - most probably fear.

Much of the time fear is incredibly useful to us. It alerts us to danger and so keeps us alive. As a result, we appear to have evolved to become extremely sensitive to it.

The Iowa researchers now believe that fear might explain one of the biggest unsolved mysteries in economics. It is called the "equity premium puzzle".

Why is it that so many of us prefer to earn our money in interest rather than from shares, even though the payout from shares is usually much higher?

Conventional economics can't provide an answer. Indeed, some economists dismiss the puzzle as a statistical illusion.

But if the Iowa researchers are right, our behaviour begins to make sense. We may be so frightened of risking money, even if it is only a tiny amount - as little as $1 - that we are prepared to forgo the opportunity of earning much more. Fear may hold our finances hostage. The trick for those of us who would actually like to make money is to break free.

One way may be to hand over the management of our finances to someone else. Professional fund managers may well do a better job of managing our money than we would ourselves precisely because they don't act as if it is their own. They are prepared to take risks with our money that we couldn't stomach taking ourselves.

Another way might be to be genuinely free of responsibilities.

Millionaire winner Fulton says he took the plunge and went for the million in last Monday's show because he "didn't really have a lot".

In his words: "I lived in a one-bedroom unit. I wasn't really heading anywhere so I thought, 'I've got nothing to lose'."