Hersh Shefrin: Understanding Human Behavior to Make Better Decisions

Hersh Shefrin is a pioneer of the field behavioral finance. Dr. Shefrin serves as the Mario Belotti Chair in the Department of Finance at Santa Clara University's Leavey School of Business, and he has worked at Santa Clara for 40 years. He grew up in Canada, and did his undergraduate work at the University of Manitoba.


Dr. Shefrin has written several books including “Behavioral Risk Management” in 2015 about how financial disasters and mistakes almost always have behavioral roots. He has also written textbooks and dozens of academic articles. Dr. Shefrin contributes to Forbes, and has his own Wikipedia page


In this conversation, Dr. Shefrin tells the story of how he got interested in behavioral economics, a story that involves some of the most famous psychologists of the 20th century. We also zoom in on personal decision-making tactics, how to think about self-control, and tips for young people about investing in volatile times. Here's his Twitter.

Interview Highlights

Gavin Cosgrave: How did you first get interested in behavioral economics? How did your career start out?


Hersh Shefrin: As an undergraduate, I was interested in physics, mathematics and economics. I went through all three programs, but I ended up going to grad school first in mathematics then economics. I was really lucky, I worked with incredible people.


In the film, The Imitation Game, the real hero who broke the Nazi code wasn’t Alan Turing, but my professor William Tutte at the University of Waterloo in Ontario. That was a secret until four years ago.

I went to the London School of Economics to do my PhD. and build models about how economies function. It was very compelling and fascinating to think about how you could build models about what’s happening in the social and human world. In the course of doing it, I came to realize that the models missed a lot of the human dimensions. The most important thing that seemed to be missing pertained to emotions and mistakes.


The assumption was that people knew how to optimize. Just by looking at the world around me, I could tell that that wasn’t how people functioned. When I became a professor myself, I wound up at the University of Rochester where another junior faculty member was interested in the same set of issues. He was further along with me and had made contact with cognitive psychologists.


On my side, I had been interested in studying why American women in particular are so focused on dieting behavior, and why it’s so difficult to come up with and follow the right diet. My wife was an academic at the time, and she was reading the medical literature. My colleague was also involved in dieting research, and his name was Richard Thaler. (Note: Richard Thaler was the 2017 recipient of the Nobel Prize in Economics)


He and I began to have conversations about how to bring these ideas about human imperfections, emotions and self-control challenges into economics. I’m a theorist, and I wanted to build models about how people developed self-control. At that time, no one was calling themselves “behavioral economists."


The greatest stroke of good luck for me was that Richard Thaler had already made contact with the two psychologists who are thought of today as the most important of the 20th century, and that was Daniel Kahneman and Amos Tversky. I had already been reading their work, but I got introduced to them at Stanford. It’s one thing to read someone’s work, but I got to sit down in person and discuss it with them.


GC: Let’s imagine that I’m a student weighing a few different options on how to spend my summer. I could do an unpaid internship in my hometown with a non-profit that is more in line with my career. I could take a job at Starbucks near Santa Clara and be closer to friends and make some money. Or I could go abroad to India for 8 weeks and work with a social enterprise. What types of biases should I watch out for, and how would you recommend I made my decision?


HS: There are two ways to think about the issue. The first is understanding the trade-offs. If you were a completely rational decision maker, you would sit down and write down all the pros and cons, then decide which are most important and determine the right decision. That would be if the rational Gavin was in charge.


But suppose it’s the case that there are other issues that weigh on your mind. Maybe you would miss your friends, you an interest in having more money, or you know that the abroad experience would really make you as a person. But the immediacy of wanting “now” in your mind is receiving a high degree of importance. 


A second thing is to think about whether you’re starry-eyed. It might be that the abroad internship isn’t the right experience for you because you think it’s going to be fabulous when, if you talked to someone, you would find it’s not everything it’s cracked up to be. Will you succumb to confirmation bias and think it’s all going to work out? Those are the kinds of cognitive errors that might be important to you.


GC: People often wish they had more self-control. How can we improve self-control?

HS: There are two questions. One is: Am I vulnerable to not handling self-control challenges as effectively as I might? That could involve not studying hard enough or drinking too much. Issues where you find it difficult to delay gratification.


The second is: What can you do about it? Facing up to it squarely is step one. What the psychology literature suggests is that developing good habits is critical, but if you have to rely on willpower, you have to distract yourself. You have to focus attention on something else besides this urgent need that your brain recognizes that you know aren't good for you.


GC: What are a few tips you have for young people to effectively invest?


HS: Understand why you want to invest. Do you want to get rich quick or build a nest egg for the future? If you want to build a nest egg for the future, ignore everything about what’s happening now. Invest in a sensible place in an asset class that’s likely to generate high-quality returns over time. If you’re well-diversified and you’re in an asset class like equities, don’t worry about what happens in the next couple years.

Five or ten years out, it’s unlikely that you’ll be behind by starting now. If you’re worried about looking stupid, which is the emotion that happens when we enter a bear market, you have to have a conversation with yourself about what good long term investing means. It means being willing to look like an idiot in the short term because the odds are you’ll look really smart in the long term.


If your objective is to get rich quick and look smart, whatever money you use to do that is kind of like playing the lottery. That money is money you can afford to use, play money.


GC: If you could send a message to everyone in the United States, what would you want to say?


HS: Follow the golden rule, and keep future generations who have no voice in mind as you follow that golden rule.