For a number of years earlier in my career, I labored under a misconception about the word “satisficer.” In my mind, “satisficer” was a sociologist’s term for what happens when you cross a slacker with a well-adjusted productive person, yielding an employee who enjoys many of the benefits of productive normalcy without the pressure of actually having to produce much.
Basically, I thought a satisficer was a slacker with style and an office. My equation did not include a variable for managing downside cubicle risk. In hindsight, I admit that this omission was a serious flaw.
As it turns out, however, “satisficer” doesn’t refer to the type of hybrid individual I just described. Instead, it was coined by a Nobel Prize-winning economist, Herbert A. Simon, to describe two different approaches to decision making. The first type of decision maker is the maximizer. A maximizer asymptotically seeks the perfect solution (although it may be unattainable). The other type is the satisficer. A satisficer seeks the good-enough solution (because they believe perfection is not attainable, and hey, they’ve got surfboards to wax and gnarly waves to catch).
So Simon came up with a good observation about how people tend to operate, but in a practical sense, his idea didn’t go anywhere for a while. He might have gotten more traction by turning it into a self-help book with a catchy title, like From Bad to OK: The 10 Imperfect Haphazard Solutions of Partially Effective People.
Still, Simon’s maximizer–satisficer model didn’t go entirely unnoticed. Of course, there was that little thing about a Nobel Prize, although that honor was awarded more for Simon’s body of work than for this one particular insight. Psychological researchers found it useful and started studying the two different modes of decision making. Eventually, a finance professor attempted to “operationalize” it. Trying to reconcile the efficient markets hypothesis with counterexamples identified by behaviorists, Andrew Lo of the MIT Sloan School extended Simon’s idea about satisficing and combined it with “evolutionary dynamics.”
Under the adaptive markets hypothesis, as Lo calls it, examples of decision making that behaviorists consider economically irrational are actually just behaviors that were adapted to a different environment. For example, take a band of Paleolithic human hunter-gatherers living on the African savanna. If they saw a dangerous predator, calculating the optimal solution (in other words, maximizing) would not have been a survival-efficient response. On average, a rapid-fire good-enough decision was more likely to help them avoid being attacked. In the modern world, the descendants of these quick-thinking survivors may struggle with decisions that demand a more complex assessment of probability and expected payoff.
Consequently, many ages later, humans aren’t natural maximizers and markets are not efficient in the classic strong-form sense. The ultimate implication of the maladaptive human factor is that major factors or fundamentals (such as, say, the equity risk premium) can change over time. In his original paper, Lo didn’t venture to say whether this situation is a good thing or not. He was trying to describe reality, not justify it. But I will.
Satisficing is good for markets.
Just imagine markets driven by maximizers, which is what classic theory would require. Choosing a fund manager would be impossible because you would need decades of data to determine (with reasonable statistical confidence) whether a manager’s past performance was a result of skill or luck. Compared with that, someone who tries to choose a manager based on five years of performance data is being recklessly impulsive.
It reminds me of the science fiction novel The Hitchhiker’s Guide to the Galaxy. An alien race programs the ultimate computer to give them the answer to life, the universe, and everything. The program takes thousands of years to run. When the day finally comes, a breathless planet is told the answer: 42. The computer explains that, unfortunately, they didn’t ask an actual question, but when they finally figure out what the proper question is, the computer is absolutely certain that 42 will be the answer.
A similar fate would probably await any investor who took a true maximizer’s approach to decision making. The true answer to market efficiency, risk–return tradeoff, and everything would be either unattainable or meaningless, if only because we still don’t know what the right question is. In fact, some psychological research indicates that maximizers tend to become neurotic, spending too much time obsessing over details, options, and permutations. They are also more likely to experience regret and dissatisfaction about their choices.
In short, if it wasn’t for the impulsive, overconfident, irrationally exuberant, cognitively biased masses and their quirky behavior, we would have no markets at all. All those people on the wrong side of transactions buying mispriced securities are actually serving a higher purpose.
Granted, it’s better to be the impulsive, overconfident, irrationally exuberant cognitively biased people on the winning side of the transactions. Personally, however, I’m looking for a third way. What do you call someone who seeks the perfect good-enough solution? A maxificer?
The article was first published on blogs.cfainstitute.org