What Intelligence Tests Miss

by Keith E Stanovich

  subject 9:

  Rationality and intelligence are definitely related in that their definitions largely overlap. Both include an ability to reason or think logically. They go together in a sense that one who is rational is usually intelligent. They differ dramatically when looking at the inverse. For example, one can be intelligent (clever, bright) but in no way rational (behaving in an acceptable, reasonable manner). In the minds of many, Saddam Hussein is intelligent but is not rational. They differ in their expressions. Being rational or irrational is definitely more observable through one’s actions and behaviors rather than through their thoughts.

  Subject 10:

  Rationality and intelligence are both related and unrelated. I feel that in order to behave rationally one must have intelligence in order to think about their behavior. Since rational behavior is behavior ruled by the head intelligence does play a part. The reason I think they are unrelated is that very intelligent people can and do exhibit irrational behavior. This is most often done when people’s emotions take a hold and people act on them without intelligently thinking them through.

  Subject 13:

  Rationality and intelligence are related in certain ways; However, a person can be very rational and not very intelligent at the same time and vice versa. Many people have good or common sense abilities which would be rational ones; however, a lot of these people are not considered to be vastly intelligent. Although they have good rationale, thinking and behavior ability, they may have difficulty understanding, perceiving, and processing information (i.e., they may not be book smart, but are very street smart or good at everyday situations.) On the other hand there are many intelligent people who have the ability to easily comprehend information or stimulus but could not think or reason themselves out of a shoe box. I feel rationality and intelligence are definitely different; they are related at times, but a person could easily have the ability to be one or the other.

  subject 17:

  Rationality and intelligence are related in that they both use reasoning and understanding. However, I believe intelligence, or one’s capacity to obtain knowledge is somewhat innate whereas rationality is learned. An individual can learn to make rational decisions from being exposed to one’s environment and its expectations. I do feel that rationality and intelligence are related in that if a person is intelligence [sic] then they can grasp rationality faster. They will understand concepts, experiences, and other things in a different manner than if they were unintelligent.

  subject 30:

  Rationality and intelligence are very closely related. Both require the ability to look at subjects from each perspective and to be able to take these subjects apart and analyze each part. . . . Rationality, however, is expressly the ability at a specific time to keep all emotions out of the decision making process. In this respect someone who is intelligent may do irrational things at times. Also, someone who is rational and even tempered will have the ability to think things through but may not have the ability to see how his/her decisions will affect the future situation. In some senses, rationality and intelligence seem related, but in other areas they are quite different.

  These responses indicate that folk psychology does seem to recognize dysrationalia, and in doing so it signals that it does distinguish between intelligence and rationality. Of course, this might have been more true in our experiment because previous questions drew attention to the concept of rationality and perhaps suggested the possibility of separating it from intelligence. But this is just my point. When they were given the term rationality (which they do not tend to think of spontaneously) our subjects had no trouble differentiating rationality from intelligence and then saw little difficulty in explaining the observation of smart people acting foolishly.

  I hope now that the title of the chapter—Cutting Intelligence Down to Size—has been contextualized. What needs to be cut down to size is our conceptualization of intelligence—the tendency to incorporate all important mental qualities into it or to append it to every valued mental quality that we wish to praise or highlight. Instead, we should conceptualize intelligence as MAMBIT. By constricting the term intelligence we will create conceptual space for other qualities (rational thinking) that are currently given short shrift because they are not measured on IQ tests. Our culture’s fixation on the intelligence concept has obscured other mental qualities that society needs at least as much. The failure to develop these mental qualities leads to dysrationalia. In the next several chapters we will see why dysrationalia occurs and why it is not rare—in short, we will see why intelligence is no inoculation against irrational thought and behavior.

  FIVE

  Why Intelligent People Doing Foolish Things Is No Surprise

  My counterfactual, introspective, and hard-thinking ancestor would have been eaten by a lion while his nonthinking but faster-reacting cousin would have run for cover. . . . Evidence shows that we do much less thinking than we believe we do.

  —Nassim Nicholas Taleb, The Black Swan, 2007

  In effect, all animals are under stringent selection pressure to be as stupid as they can get away with.

  —Peter Richerson and Robert Boyd, Not by Genes Alone, 2005

  You do not need to look far for examples of dysrationalia. In the domain of personal finance, the cases of John Paulos and David Denby discussed in Chapter 2 are not atypical. We now know why intelligent people like Paulos and Denby tend to lose a lot in the market during bad times, and why even during good markets many intelligent people do not make much money. Consider for a moment a very volatile period of the stock market, from the beginning of 1998 to the end of 2001. During that period, the Firsthand Technology Value mutual fund did very well. Its annualized total return for this period was 16 percent—that is, its average gain for this period was 16 percent per year. Yet the average investor who invested in this fund lost 31.6 percent of his or her money over this same four-year period.1 From 1998 through 2001, a period in which the annualized return of the fund was +16 percent, investors lost a total of $1.9 billion (yes, that’s billion with a b) by investing in this fund. How could this be true? How could investors have lost money in a fund whose investments showed an annualized gain of 16 percent over the same period?

  The answer dawns after a moment of reflection. The +16 percent annualized return of the fund would have been the gain for any investor who was in the fund at the beginning of 1998 and stayed in it continuously through the end of 2001. But most investors did not stay in the fund throughout that period. They invested in the fund at different points and they cashed out of the fund at different points—and often the same investor came in and out of the fund multiple times. The Firsthand Technology Value fund was a very volatile fund during this period. When it gained, it gained a lot, and when it lost, it lost a lot. And now the seeming paradox is easily explained (in a way that says something about the prevalence of dysrationalia). Investors lost a tremendous amount of money in the fund because they invested and cashed out at exactly the wrong times. In other words, they bought the fund when it was high and sold when it was low. And because when it was high it was very high, and when it was low it was very low, such behavior resulted in extremely large losses to the individuals engaging in it.

  Such self-defeating behavior was not limited to the Firsthand Technology Value fund. For example, during the same time period, Janus Mercury fund had an annualized return of +13.9 percent, but its investors lost money (annualized return of −7.4 percent); Fidelity Aggressive Growth earned an annualized return of +2.8 percent, but its investors realized an annualized loss of 24.1 percent; and the Invesco Dynamics fund had an annualized return of +7.0 percent, but its investors nevertheless lost money (−14.4 percent annualized return). Reporting on a study of 700 mutual funds during 1998–2001, financial reporter Jason Zweig notes that “to a remarkable degree, investors underperformed their funds’ reported returns—sometimes by as much as 75 percentage points a year” (2002, p. 112). Zweig tells us that across the 700 f
unds the average total return was +5.7 percent annualized, but that the average investor earned only +1.0 percent. Zweig quotes Lawrence Siegel of the Ford Foundation as saying that “if investors earned the rates of return that the funds report, we’d all be rich. And why aren’t we all rich? Because people keep shooting themselves in the foot” (p. 113). People who “keep shooting themselves in the foot” are irrational. Because most stock investors are high-income individuals and high incomes are associated with higher educational attainment, we can be assured that this gargantuan example of suboptimal behavior (investors lost over $200 billion of potential gains) represents dysrationalia on a truly massive scale.

  Cognitive scientists now know quite a bit about the psychological processes that sustain such widespread dysfunctional behavior. For example, many people suffer from overconfidence in their knowledge calibration. They think that they know more than they do, and they think they can process new information better and faster than others. This is an astoundingly bad mental trait to have as a stock market investor, because major markets are simply crawling with talented individuals analyzing financial data with sophisticated technological aids. Most of what these analysts have figured out about the market in general and about specific stocks in particular is already represented in the market price for a specific security. For “weekend investors” to think that they can figure out something about the market for a particular stock that these analysts have missed and use it to advantage is pure folly, yet thousands of investors (many with quite substantial IQs) are afflicted with this dysfunctional thinking trait. As a result, they display an investment behavior that lowers their overall return: they trade too much. Their too-frequent trading incurs additional transaction costs and, because their behavior is not based on any superior knowledge, their attempts at “market timing” (going in and out of the market repeatedly) also lower their return. Ironically, less confident investors tend to default more to a “buy and hold” strategy that has been judged superior by personal finance professionals. Psychologists have developed ways to measure this mental trait—the tendency toward overconfidence—that has such a significant effect on investing behavior.

  The second psychological characteristic that leads people to make investment mistakes can quite often be useful. Our brains have evolved in such a way that they engage in a relentless search for patterns in the world. We seek relationships, explanations, and meaning in the things that happen around us. This characteristic is obviously very adaptive, but it backfires on us by encouraging us to expend effort trying to explain chance events. This is exactly what happens to some investors in the stock market. Markets generally, and individual companies more specifically, are buffeted constantly by small unpredictable events that move stock prices somewhat but really have no effect on a company’s ability to pay future dividends over the long term (the factor that critically determines the value of its stock). It is a mistake to try to explain these chance events and react to them, yet some investors have a very low threshold for doing so (they tend to over-react to chance events). The psychological disposition to seek explanations for chance events leads people to trade too much, thus reducing their overall long-term return (by incurring excessive transaction costs).

  The third factor that leads to overtrading is called myopic loss aversion. It represents part of the work for which cognitive scientist Daniel Kahneman won the 2002 Nobel Prize in Economics. As part of their prospect theory of judgment and decision making, Kahneman and his colleague Amos Tversky posited that the expected subjective valuation of losses is roughly twice as strong as that of expected gains. That is, the pain that people feel they will experience when losing $100 is roughly twice as strong as the pleasure that they feel they will derive from gaining $100. That is where the term loss aversion comes from.2 The “myopic” part of the phrase refers to our tendency to monitor investments on a time scale that is out of sync with the life span of the investment. For example, a 40-year-old individual invested for retirement would display myopic monitoring if she checked her investments hourly or daily (or even weekly). Professionals would recommend that such an individual check her investments monthly at most (more optimally, only 4–5 times a year).

  Wait—isn’t more information always better? What could be wrong with monitoring frequently? Plenty, actually. The stock market is volatile. There are many ups and downs. People are quite scared of losses (recall loss aversion) and thus tend to react strongly to downward price spikes. Each dip that is observed becomes a temptation to cash out and avoid or limit the loss. Individuals monitoring more frequently are presented with many more such opportunities and, not surprisingly, they are more likely to succumb to this temptation than are those monitoring infrequently. Then, once cashed out, individuals who frequently monitor are also more likely to have noticed when things have calmed down and prices are up—in short, when things seem safe. And, once they buy back into the market under these conditions, they have completed a cycle that perfectly illustrates what not to do in the stock market: sell low and buy high.

  The factors discussed here—overconfidence, over-reacting to chance, and myopic loss aversion—are now accepted explanations of maladaptive behavior in the domain of personal finance. Work in cognitive psychology has shown that people vary in each of these processing styles and that this variation can be measured with laboratory tasks. Furthermore, that variation is known to be largely independent of intelligence—leading to a truly colossal example of dysrationalia: millions of quite intelligent investors losing billions of dollars of potential gains. Dysrationalia is clearly widespread. Why is this the case?

  Humans as Cognitive Misers

  The human brain has two broad characteristics that make it less than rational. One is a processing problem and one is a content problem. Intelligence provides insufficient inoculation against both.

  The processing problem is that we tend to be cognitive misers in our thinking. The finding that humans are cognitive misers has been a major theme throughout the past 30 years of research in psychology and cognitive science.3 When approaching any problem, our brains have available various computational mechanisms for dealing with the situation. These mechanisms embody a tradeoff, however. The tradeoff is between power and expense. Some mechanisms have great computational power—they can solve a large number of problems and solve them with great accuracy. However, this power comes with a cost. These mechanisms take up a great deal of attention, tend to be slow, tend to interfere with other thoughts and actions we are carrying out, and require great concentration that is often experienced as aversive. In contrast, other brain mechanisms are low in computational power but have the advantage that they are low in cost. These mechanisms cannot solve a wide range of problems and do not permit fine-grained accuracy, but they are fast-acting, do not interfere with other ongoing cognition, require little concentration, and are not experienced as aversive. They are the Type 1 processes discussed in Chapter 3, which are sometimes also termed heuristic processes.

  Humans are cognitive misers because their basic tendency is to default to Type 1 processing mechanisms of low computational expense. Using less computational capacity for one task means that there is more left over for another task if they both must be completed simultaneously. This would seem to be adaptive. Nevertheless, this strong bias to default to the simplest cognitive mechanism—to be a cognitive miser—means that humans are often less than rational. Increasingly, in the modern world we are presented with decisions and problems that require more accurate responses than those generated by heuristic processing. Type 1 processes often provide a quick solution that is a first approximation to an optimal response. But modern life often requires more precise thought than this. Modern technological societies are in fact hostile environments for people reliant on only the most easily computed automatic response. Think of the multi-million-dollar advertising industry that has been designed to exploit just this tendency. Modern society keeps proliferating situations where shallow processi
ng is not sufficient for maximizing personal happiness—precisely because many structures of market-based societies have been designed explicitly to exploit such tendencies. Being cognitive misers will seriously impede people from achieving their goals.

  Why We Are Cognitive Misers

  We humans will find any way we can to ease our cognitive load and process less information, but this is why we are often less rational than we might be. But why are we cognitive misers and as a result less than fully rational? In a word—evolution. Our cognitive mechanisms were designed by evolution, and evolution does not operate to produce humans who are perfectly rational.

  There are a number of reasons why evolution would not be expected to guarantee perfect human rationality.4 One reason is that rationality is defined in terms of maximization (for example, in the case of instrumental rationality, maximizing the expected utility of actions). In contrast to maximization, natural selection works on a “better than” principle. As Richard Dawkins puts it, “Natural selection chooses the better of present available alternatives. . . . The animal that results is not the most perfect design conceivable, nor is it merely good enough to scrape by. It is the product of a historical sequence of changes, each one of which represented, at best, the better of the alternatives that happened to be around at the time” (1982, p. 46). In short, the variation and selective retention logic of evolution “designs” for the reproductive advantage of one organism over the next, not for the optimality of any one characteristic (including rationality). It has been said that evolution should be described as the survival of the fitter rather than as the survival of the fittest.