LISTEN: Taming the Invisible Gorilla (mp3audio) (17:21 min)

Have you heard the one about the invisible gorilla?

Two researchers created a short video of two groups of students passing a basketball to one another. The video lasted about 45 seconds and was completely unremarkable, except for one thing: About halfway through the video, an actress in a gorilla suit walked into the middle of the two groups, beat her chest a few times and walked out. The “gorilla” was on-screen for nine seconds.

Researchers asked viewers to count the number of times the basketball passed between members of one of the groups. After viewing, they were also asked if they had seen the gorilla. 50% of the respondents were so focused on counting passes they never saw the gorilla!

This video, first shown in 1997, is the basis for a new book “The Invisible Gorilla and Other Ways Our Intuitions Deceive Us” by Christopher Chabris and Daniel Simons. Full of data from various experiments similar to the gorilla video (to see this video, and others like it, you can go to http://www.theinvisiblegorilla.com/videos.html), the book presents a strong argument that many of our perspectives and actions in life are distorted by “illusions.” As a result, we either miss or misinterpret much of what is going on around us. In the authors’ words, “Indeed, virtually no realm of human behavior is untouched by everyday illusions.”

One reviewer described The Invisible Gorilla as “a humbling journey into the fallibility of our thinking.” Not only are we messing up, we don’t even know it.

Chabris and Simons call the illusion in the gorilla video the Illusion of Attention. It is our “inattentional blindness” which causes us to “experience far less of our visual world than we think we do.” But this isn’t the only type of illusion that leads us astray.

There is the Illusion of Memory. Our ability to recall ideas and events – even the most significant “flashbulb moments” like 9/11, our marriage ceremony, or the birth of a child – is nowhere as sharp as we think it is. Often our memories are embellishments rather than facts, like the fish that gets bigger with each telling.

Another common mistake is the Illusion of Knowledge. Personality assessment tests often ask respondents how many authors they have read, or which concepts seem familiar. Included in the list are fictitious names, and ideas that don’t exist. Yet, many people will claim knowledge of these non-existent people and ideas. Even when there’s no way of knowing, we still think we might have known.

Closely related is the Illusion of Cause. We not only think we know what happened, we think we know why it happened. If someone told you that every time they got a haircut the stock market went up, would you laugh or start checking their calendar? There might be a correlation, but it’s tough to think there’s a causal connection between the two events, right? Of course, when someone on the business channel does the same thing comparing the Super Bowl winners and the stock market, or the price of chocolate and inflation, we think, “you know, he might be right.” In reality, there are often too many causes and too many effects to think we can discern which cause triggers another effect.

Even more challenging is the Illusion of Confidence. As Wall Street Journal reviewer David Shaywitz puts it in an article from June 11, 2010, “we profoundly underestimate our capacity to be fooled.” We too often associate confidence with competence; if people act confidently we assume it must be because they are good at what they do, or precise in their knowledge. But the phrase “con man” is short for “confidence man.” At the heart of many poor financial decisions is misplaced confidence in an individual.

Because these illusions exert such great influence over us, most of us tend to overestimate our intelligence, attractiveness, abilities, and sense of humor. At the same time we underestimate the challenges we face, and our own limited abilities to respond to them. Given these factors, it’s no surprise that we often miss what’s most important, and even ignore the warning signs telling us we are headed for trouble.

If we are all so blinded by our illusions, are good decisions impossible? Several reviews of The Invisible Gorilla have pointed to the practical ramifications of the findings. For example, the illusions concept offers a convincing explanation of why so many people make poor financial decisions. The illusions in The Invisible Gorilla offer plausible explanations for the overwhelming tendency of individual investors to buy high and sell low, or forgo disability insurance, or take a mortgage beyond their means. In fact, given the illusions that hold sway in our lives and our unawareness of them, poor financial decisions are not surprising. Rather, they are almost inevitable. How then, can individuals deal with the invisible gorillas in their lives?

Get smarter. Once you become aware of the impact of illusions on your perceptions, you can change, at least in theory. So now that you know there’s a gorilla in the video, you should be able to find it, and respond appropriately. But looking for the gorilla often means not seeing something else. As a follow-up to their 1997 video, the authors made a new one. Like the first, this one featured two groups passing a basketball and a person in a gorilla suit. But this time, other factors changed as well. First, one group member left the stage as the gorilla entered. And during the course of the film, the background curtain changed from a deep red to gold. Viewers who knew about the gorilla and were told to count the number of passes correctly noted both items – but most missed the additional changes. Focusing on one thing precluded awareness of others.

Getting smarter helps, but even if you know more about what you’re missing, it is still impossible to know it all. We simply cannot process all of the input. We can’t watch every business news channel, read every financial publication, and study every report – about gorillas, or money, or anything else. We have illusions because we must filter and prioritize. So while our filters may get better, they can’t catch everything.

Turn the decision-making over to someone else. In every experiment done by Chabris and Simons, some people did notice the gorilla, or caught other changes embedded in the tests. So while you might be easily fooled by the illusions of life, perhaps there are some people who aren’t. If only you could find one of those “smart ones” perhaps they could help you successfully manage your financial affairs, right?
Indeed, many people have achieved great acclaim for being smarter than everyone else when it comes to money. Over time, these people seem to have a knack for knowing what to do and when to do it. Probably the best-known financial savant of our time is Warren Buffet. The “Sage of Omaha” has become one of the richest individuals in the world as the manager of the Berkshire-Hathaway investment fund. Buffet might make some mistakes, but he seems to make far less than the rest of us. Many people have done well by letting Buffet be their financial stand-in.

Unfortunately, the same thought process, of getting a smarter person to handle one’s financial affairs, made it possible for Bernie Madoff to perpetuate his $36 billion investment scam for more than 20 years. Madoff’s representations of consistently above-average returns wowed potential investors and buffaloed investigators. The illusion of confidence in Madoff was so great that no one saw the underlying scam until a poor economy spurred some investors to cash out. When Madoff’s Ponzi scheme started to flow in reverse, his house of cards collapsed, leaving thousands of investors with losses estimated between $12 and $20 billion.

This isn’t meant to imply that all smart people have the potential to be con artists. Even well-intentioned people who are smarter than you may not be smart enough to avoid the pitfalls of financial illusions.

Find the perfect plan. If you can’t trust yourself and you can’t trust other people, then you might reason “let’s remove the human element”. Put a system of rules in place that leaves no room for human fallibility. Get a computer to make the decisions. This is the driving idea for formulating risk-tolerance models, target funds, and all sorts of regulatory agencies.

These plans may eliminate human decision-making, but that doesn’t make them fail-safe. First, the plans were designed by individuals – you know, those people operating under illusions. All sorts of ingenious ideas and complex computer-driven models have been failures, sometimes spectacular failures.

Second, most plans, even the ones that attempt to predict the future, are based on past experiences. This backward-looking planning technique is one of the reasons financial regulation often fails to prevent abuses (like the collateralized mortgage obligations that precipitated the housing bubble). Cheaters are constantly seeking new ways to bend the rules and game the system, however regulators are constantly behind the curve. Any adjustments they make (“we can’t let this happen again!”) only reflect what would have been the perfect plan for the past, not what will be the perfect plan for the future.

Can anything tame the Invisible Gorillas? This can be depressing. You realize that you can’t trust yourself to make all of the right moves. You can’t entirely trust other people, because even with best intentions, they’re just like you. And you can’t trust  finding a perfect plan, either. Given these truths, it’s almost logical to conclude that most of us are destined for financial ruin, and there’s not much we can do about it.

Risk Management: the Wabi-Sabi for the Invisible Gorilla. In Japanese, the phrase “wabi-sabi” represents a comprehensive world view centered on the acceptance of transience. The Wikipedia entry says a key element of wabi-sabi is finding beauty in things which are “imperfect, impermanent and incomplete.” Accepting that it may not be possible to achieve the perfect outcome, the wabi-sabi approach looks for ways to make things work.

Given the evidence from Chabris and Simons, no one – no matter how well-informed and self-aware – can ever know enough and/or be level-headed enough to avoid making some mistakes in observation and judgment. Accepting that mistakes are unavoidable, the logical response is to prepare for them. Instead of trying to avoid all mistakes, take steps to manage them. Particularly in regard to your financial affairs, a risk management approach is an effective way to handle the invisible gorillas in your world, because it acknowledges that many aspects of your financial life are “imperfect, impermanent and incomplete.” For example…

If you can’t guarantee a good investment outcome, don’t put all your money in one place. If you can’t be sure you will avoid all accidents, having insurance is a no-brainer. You may anticipate steady employment, but establishing a substantial cash reserve is always a smart decision. Instead of relying exclusively on one person to help you with your financial decisions, cultivating a team of professionals can provide either a consensus, or a range of alternatives. Risk management says: In all things, hedge your bets.

It’s not an easy sell, because risk management isn’t a concept with a lot of sizzle. There’s no promise of outrageous returns, or magic formulas, or revealed secrets of the rich and famous. But risk management is the only financial approach that can handle the invisible gorillas that often lay waste to your financial aspirations.

Even if you accept the risk management paradigm, there is still a chance that these decisions may leave you slightly dissatisfied. If one fifth of your investment portfolio delivers outstanding returns, you may wish you’d invested all of it in that account. If you don’t have an auto accident or a disability claim, the insurance premiums may seem like wasted expenditures. And if everything goes your way at work, you may be tempted to use those cash reserves for a vacation to Tahiti. You begin to think, “I’ve got it figured out.” And thus the illusions of memory, knowledge, cause and confidence begin to tug at you again. The invisible gorillas are back.

A few critics of the Invisible Gorilla have said the research seems to discourage risk-taking and initiative, which are often seen as the drivers of a healthy expanding economy. After all, if everyone is incompetent, and risk management is the best response, how will any innovation ever take place?

It may seem counter-intuitive, but good risk management allows for the most risk-taking. People with a solid financial footing can afford larger risks and have a better chance of surviving failures. It is human nature, given our propensity to embrace illusions, to believe that magic formulas exist, and all of our problems would be solved if we could just find the magic formulas and apply them to our personal circumstances. But pursuing ideal illusions can get in the way of establishing workable plans. Financial risk management should be at the foundational base of every financial program. Neglecting this fundamental element is building a financial life based on illusions.

FINANCIAL RISK MANAGEMENT MAY BE “BORING,” BUT IT WORKS.  HOW SOLID IS YOUR RISK MANAGEMENT PLAN?