'Financial Fitness Forever' by Paul Merriman shows the human mind is strange

BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

BOROSON ON MONEY

Someone — let’s call him George — stops a stranger on a college campus and asks for directions.

As the stranger helpfully studies a map and starts to give George directions, two workingmen carrying a long door walk between them. For a moment, the stranger cannot see George. The door is blocking his view.

Quick as a bunny George scoots away, and is replaced by someone else. (George and the other guy are part of this experiment.)

This new guy looks very different from George. Taller, shorter, fatter, skinnier, older, younger, whatever.

Yet the stranger doesn’t seem to notice the change — and keeps on giving directions to the new guy! As if he were George!

This experiment has been repeated many times, each time with the same result.

Paul Merriman, a money manager in Seattle, refers to this curious experiment in his new book, “Financial Fitness Forever” (McGraw-Hill), and his point is that we human beings may not even notice the obvious. Which helps explain why we are so lousy at investing. And why we might seriously consider buying into index funds, which don’t depend for their success on fallible human judgment.

Regarding that experiment. I suspect that all the strangers noticed the change – but didn’t know how to deal with it. It didn’t make sense. So they tried to ignore it and think about it later, if at all. That’s a typical response if a stock or mutual fund we own plummets – for no apparent reason. We’re befuddled -- and do nothing.

A fellow I knew, Jeff, once told me that a stranger had walked up to him, asked “Isn’t your name Jeff?”, then – laughing like a maniac – had run off. Jeff was perplexed, puzzled, upset. I told him that it was practical joke. Someone who knew Jeff put that guy up to it.

When we’re confronted by something that doesn’t make sense, we tend to try to ignore it, at least temporarily. And perhaps that’s sensible.

Merriman describes another interesting experiment in his book.

A group of students were exposed to a screen on which a light flashed again and again, either red or green. The sequence was random, but four out of five times the light was green. After each flash, the subjects were asked to guess which color will come up next.

When a bunch of rats were subjected to this experiment, they were given food whenever they guessed right. Fairly quickly they figured out: always guess green. You get more food that way.

But the students were too smart for that. Even after they were told that the flashing was random and the light would be green four out of five times, they tried to do better. Yes, they picked green four out of five times. But not every time!

By trying to do better than 80 percent, by finding a pattern in the light flashes, they did worse. That reduced their accuracy rate to 68 percent. (“Fooled by Randomness” is the title of a book on the subject of our attempts to find patterns when none exist.)

The lesson is not that rats are cleverer than people. (Though that seems a reasonable conclusion.)

Another possible lesson: Invest in index funds. Forget about trying to choose the best stocks.

My own intepretation: Those kids didn’t know what the word “random” meant.

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