Algorithms to Live By: The Computer Science of Human Decisions

by Brian Christian

The Upside of Heuristics The economist Harry Markowitz won the 1990 Nobel Prize in Economics for developing modern portfolio theory: his groundbreaking “mean-variance portfolio optimization” showed how an investor could make an optimal allocation among various funds and assets to maximize returns at a given level of risk. So when it came time to invest his own retirement savings, it seems like Markowitz should have been the one person perfectly equipped for the job. What did he decide to do? I should have computed the historical covariances of the asset classes and drawn an efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it—or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions fifty-fifty between bonds and equities. Why in the world would he do that? The story of the Nobel Prize winner and his investment strategy could be presented as an example of human irrationality: faced with the complexity of real life, he abandoned the rational model and followed a simple heuristic. But it’s precisely because of the complexity of real life that a simple heuristic might in fact be the rational solution.