Suppose you’re given a chance to bet on the toss of a coin. If it comes up heads you win $20, and if tails you lose $10. Would you take this bet? Given a chance to do it 100 times in a row would you do it? This experiment was actually performed in a coffee shop in Westwood, Los Angeles, as explained by Jason Zweig in his book, Your Money & Your Brain.
The average outcome is to win $5 every time you take this bet. But, if you do it only once, you could lose $10 instead of winning $20. What about doing it 100 times? The expected outcome is to win $500. The odds that you’ll actually lose money are less than 1 in 2000. The odds of losing $200 or more are less than one in a million. The odds of winning more than $200 are over 97%. This is an incredibly good bet.
Amazingly, two out of three people accepted the one-time bet, but only 43% said they would be willing to repeat the bet 100 times. What are the possible explanations for the 57% of people who turned this down?
1. People are spectacularly bad at assessing which risks are worth taking.
2. Some people believed it was a trick, and that the gamble wouldn’t be fair.
3. Some people have philosophical objections to gambling. (However, because almost everything in life involves some type of gamble, it must be difficult to draw the line on this one.)
4. A few of the subjects were compulsive gamblers, and they knew that if they accepted the bet, they’d go out and lose it all and more in a casino.
5. A few of the subjects were so wealthy that winning only $5 per coin toss was a waste of their time.
I suspect that the dominant explanations of the experiments’ results are reasons 1 and 2. It’s no wonder that so many people make poor investing choices given that they would turn down a near sure thing.