What do London traders, New York stop lights and elevators have in common?

Ever wonder why sometimes it just seems to take forever for the elevator door to close despite how many times you hit the close door button?  That’s because the button doesn’t work – at least on the vast majority of elevators and usually if it does, only with a fireman’s key.  “Liar!”, you shout!  “I was in an elevator the other day and pressed the button and guess what – the door closed.”  OK….

90% of the “walk” buttons on New York City street corners haven’t worked since the 1980’s when the city implemented a new automated traffic control system.  Department of Transportation officials left them in place as “placebo buttons”, presumably to keep people from jay-walking rather than to increase happiness stemming from the illusion of control.

The “illusion of control” has been a well documented psychological phenomenon since the term was first coined in 1975 by Ellean Langer, who believed the phenomenon was largely due to people’s failure to perceive the difference between luck and skill.  Even in obviously random chance situations, experiments reveal people’s tendency to attribute success to their own skill and failure to bad luck. Her experiments concluded that early success can firmly embed a “skill orientation”.  In “Heads I win, tails it’s chance” she documents her subjects predicting the outcome of thirty coin tosses.  The feedback was rigged such that while all subjects were right exactly half the time, the sequence of success was altered.  Those subjects with early success not only rated themselves as “better” at the task but over-remembered their success rate and predicted future success.

Gamblers at casino craps tables tend to throw the dice harder for high numbers and more softly for low numbers.  People are willing to pay four times as much for lottery tickets where they pick the numbers.  Drivers estimate that accidents happen less frequently when they’re in the driver’s seat than when they’re in the passenger seat.

“Control is an illusion, you infantile egomaniac.  Nobody knows what’s gonna happen next: not on a freeway, not in an airplane, not inside our own bodies and certainly not on a racetrack with 40 other infantile egomaniacs” – Dr. Claire Lewicki, Days of Thunder

Certainly the illusion of control and other behavioural biases developed in our brains over the centuries for our benefit. However, that doesn’t mean these biases can’t adversely impact certain areas of our lives today.  This is certainly true in the field of investment and financial management.  “That wouldn’t happen to me” might lead people to ignore life insurance, put off executing wills and fail to maintain an adequate emergency fund.  When it comes to investing, illusion of control behaviour is not likely to lead to beneficial outcomes either.  One study conducted on traders from investment banks in London (Fento-O’Creevy et al, 2003) found that those who exhibited higher levels of illusion of control tended to perform worse than those exhibiting lower levels.

The Australian Securities and Investments Commission (ASIC) conducted experiments and found those prone to control biases were more likely to invest in risky hybrid securities and less likely to choose a diversified portfolio.  With investing it is extremely difficult to differentiate between luck and skill.  Those who succeed early are very likely to attribute that success to skill and that belief is not likely to serve them will in the future.  Reversion to the mean is much more common than repeated success, however current winners tell and market their stories as if they have discovered a magic formula for continued outperformance.  Investment professionals may indeed be more susceptible to these psychological biases than their clients.

Perhaps it’s just that the illusion feels better than reality.  We hit the elevator door button repeatedly in frustration but feel a rush of satisfaction when eventually we see the door close. And the funny thing is that the knowledge that the button doesn’t work is almost incidental – even if you know, you’ll still press it, willing the doors to close or summoning the walking green man to appear at your command like some genie from an ancient bottle rubbed.

Interestingly, the illusion of control also comes into effect in the opposite situation.  People tend to underestimate their ability to exert control when they actually have a high degree of control.  When it comes to financial matters, to a large extent you control how much you spend, where and how hard you work and therefore how much you earn.  The net impact is you can control how much you save and invest.  You can also control who you choose to give you advice.

The key take away from all this?  Take more control over things you can control and be wary of impulse and advice where control is illusory.