Wednesday, January 13, 2010

Taking Financial Risks is in the Genes

Researchers have found a link between attitudes towards long shot financial risks and a specific gene. We tend to like paying a small price for a long shot at a big gain such as in a lottery. At the same time, we tend to prefer paying a small price to avoid taking a chance on a big loss, which explains insurance. The researchers found that how much we like going for big gains and avoiding big losses is linked to a gene called monoamine oxidase A (MAOA).

It turns out that those with a more active version of this gene are more likely to enjoy lotteries and less likely to want insurance than those with the less active version of the gene. To overstate the results, we have two kinds of people:

1. Long shot gamblers who aren’t worried that their houses will burn down.

2. Non-gamblers who buy the $75 extended warranty on a $300 television.

An interesting question is whether many people are able to overcome their perceptions and emotions to make rational decisions. I see this as similar to the perception tricks where you’re asked which line is longer. Your brain tells you that one line looks longer, but a ruler tells you that they are both the same length. We accept that they are the same length, but one continues to look longer anyway.

For some reason almost everyone comes to the correct conclusion about the line lengths, but fewer people seem about to accept rational analyses of lotteries and insurance. In these cases, emotions and perceptions often prevail.

Thanks to a friend who pointed me to this research, but probably prefers not to be named.

9 comments:

  1. I'm working on a new product: lottery insurance. People send me the money they would have used to play the lottery and I guarantee that they wouldn't have won anyway.

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  2. Gene: Maybe there is a way to turn this into a profit-making venture. For example, I'd be willing to accept a $2 premium on a $2 6/49 ticket and guarantee to replace the ticket (if it loses) with another ticket in the next draw.

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  3. I think general investing rules like diversification and rebalancing are supposed to help us overcome our natural tendencies toward greed or panic.

    Still, that lottery scheme you guys have cooked up sounds a whole lot easier than designing a great portfolio!

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  4. There is a very good commercial from some insurance company where two men discuss "the chances" of various events, and then when a man riding an Ostrich rides by, the question, "What's the chances of that?", is asked, the correct answer is given, "100% now!".

    I think your lottery ticket premium should be a yearly subscription deal, for a $104 premium a year, you will replace every losing ticket for the $2.00 lottery.

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  5. 2 Cents: No doubt these rules help some investors, but not others.

    Big Cajun Man: Maybe we have a business plan here. Let's project $1 million in revenue for 2010 and then a 30% each year for the next 5 years. That should attract some VC funding.

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  6. MJ, very clever, in essence taking a riskless cut of $2 on any lottery win ... but are you forgetting business operation costs, your time and effort, keeping track of winners and losers? still, it's a good comment on the self-deception of schemes like PPNs, life insurance, annuities that guarantee your money back.

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  7. Canadian Investor: You're right that operational costs have to be taken into account. Approximately 3.1% of 6/49 tickets win some prize; so my gross profit would only be about 6.2 cents per ticket insured. It would take some imagination to figure out how to collect this money profitably.

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  8. That's funny. =) I guess I would fall under category 2. I always find myself buying those useless warranties that I never use. But on the other hand, when I invest, I take on a lot more calculated risks. But I always end up hedging my position with some kind of insurance (options). LOL.

    Good article. =)

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  9. Davie: Thanks. Maybe the next time you're offered an extended warranty you can take a little time to think it through and figure out if it is a good deal. I've never been offered what I considered to be a good deal on an extended warranty.

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