Behavioral Finance Warning: Humans Love Complexity

People systematically overlook subtractive changes

• Gabrielle S. Adams, Benjamin A. Converse, Andrew H. Hales & Leidy E. Klotz 
• Nature 592, 258-161
• A version of this paper can be found here
• Want to read our summaries of academic finance papers? Check out our Academic Research Insight category

What are the Research Questions?

Complexity does not automatically equate to better outcomes.

In the context of investing, complexity generally equates to over-optimization, and confusion, which can lead to investors paying too much for something they, 1) don’t really understand, and/or 2) services that don’t add any value.

We have continually emphasized the benefits of simplicity over complexity via our blog and in our book, “DIY Financial Advisor.” We have a “blast from the past” Morningstar interview between myself and Sam Lee, where we discuss the issues with complexity.⁽¹⁾

Regardless of reality and attempts by academics and advisors to educate investors on the dangers of complexity, investors seem to be seduced over and over again by investment strategies that should be simple but quickly become complex.

Why are humans seduced by complexity?

Turns out that humans love to add bells and whistles to just about everything. We simply can’t compute — easily — that sometimes removing complexity is the best solution. A recent journal article in Nature, “People systematically overlook subtractive changes“, makes this point clear:

We are doomed to desire complexity and dismiss simplicity. It’s in our nature!

A summary of the article by Nature is available here and the source article is available here.

The academic questions in this research are as follows:

1. When solving problems, do humans prefer to add components, subract components, or are they indifferent?
2. Are these preferences different under varying circumstances?

What are the Academic Insights?

Several of the key results of the paper are as follows:

1. Humans strongly favor additive solutions relative to subtractive solutions.
2. Various cues and incentives can help minimize the human tendency to ‘add’ versus ‘subract’ when it comes to problem-solving. That’s good news.

Why does it matter?

Humans rarely seek ‘subtraction’ as a solution to a problem. We see this in regulation, corporations, sports leagues, investing, and just about every function of life. While less can sometimes be more, in reality, we seek to add ‘more’ for almost all situations. A good behavioral hack is to harness the power of Charlie Munger’s inversion principle: the next time you are addressing a problem, don’t ask yourself, “What can we add here to solve this problem?” Instead, ask, “What can we subtract here to solve this problem?” You might find yourself with a better solution.

Also, you may want to pick up a copy of Leidy Klotz’s book, “Subtract: The Untapped Science of Less.“

The Most Important Chart from the Paper:

Abstract

Improving objects, ideas or situations—whether a designer seeks to advance technology, a writer seeks to strengthen an argument or a manager seeks to encourage desired behaviour—requires a mental search for possible changes^1,2,3. We investigated whether people are as likely to consider changes that subtract components from an object, idea or situation as they are to consider changes that add new components. People typically consider a limited number of promising ideas in order to manage the cognitive burden of searching through all possible ideas, but this can lead them to accept adequate solutions without considering potentially superior alternatives^{4,5,6,7,8,9,10}. Here we show that people systematically default to searching for additive transformations, and consequently overlook subtractive transformations. Across eight experiments, participants were less likely to identify advantageous subtractive changes when the task did not (versus did) cue them to consider subtraction, when they had only one opportunity (versus several) to recognize the shortcomings of an additive search strategy or when they were under a higher (versus lower) cognitive load. Defaulting to searches for additive changes may be one reason that people struggle to mitigate overburdened schedules¹¹, institutional red tape¹² and damaging effects on the planet^13,14.