Bias has been cooked into our brains by evolution and it has taken psychologists to pick through how our financial and business decisions can actually work against our goals – here’s what to watch out for, whether you’re investing in your startup or shopping in the sales…
1. You’re Happy In Your Comfort Zone
The bias most of us have heard of is confirmation bias – it’s the natural tendency to favour evidence that supports your existing opinion and ignore evidence that goes against it. If you’re running a startup with a failing product it can be hard to recognise you need to go back to the drawing board, so you might dismiss poor performance as a ‘glitch’, and double down when you need to back off. The close cousin to confirmation bias is status quo bias – without pressure to change we are naturally inclined to save our energy and leave things be.
‘Humans don’t have an internal value meter that tells us how much things are worth’
2. Your Spending Decisions Are Relative
As author Dan Ariely says in Predictably Irrational: ‘Humans don’t have an internal value meter that tells us how much things are worth.’ This is why we’re suckers for ‘bargain’ and can be manipulated to spend more than we would normally do. How many times have you gone shopping with a set budget but then spent more than that on a ‘bargain’ because it was steeply discounted? You’ve just blown your budget, but it still feels like a win. When presented with a menu we usually compare the items’ prices to each other, rather than deciding what we want to spend beforehand. So, if there’s an expensive item we’re more likely to spend more on another item, even if we don’t buy the expensive one.
3. You Confuse Being Prudent With Loss Aversion
An revealing study by Dean Buonamano showed just how much we hate to lose financially. Study participants were given $50 and asked to choose between keeping $30 or gambling the $50 with a 50/50 chance losing or keeping the whole amount. The majority acted in a risk averse way, to keep the $30 (43% gambled.) Then the experiment was switched. The participants were given $30 and told they could lose $20 or gamble the lot with the same 50/50 chance of winning or losing. This time the majority acted in a risky way with 61% gambling the lot.
This proves that when we stand to lose something we react emotionally and irrationally – we’ll do anything to avoid it, even if it costs us more in the long run. This is a real problem if you’re trying to persuade an organisation to put new money into a bold but profitable venture. The potential greater value is likely to be overshadowed by the potential smaller loss.
4. You Focus On Investments Already Made
This bias is known as ‘sunk-cost fallacy’ – to an advanced AI, sunk costs are investments that can never be recovered, so they are simply not included in future investment decisions. This would leave an AI free to make those decisions according to the current live data and future predictions. But human brains are not wired to let go of the past so easily.
Daniel Kahneman and Amos Tversky did some simple experiments to show how this works. Imagine that you’re going to see a movie costing $10 for a ticket, but when you open your wallet to pay you realise you’d lost a $10 bill. Would you still buy a ticket? Only 12% of study participants said they wouldn’t. Now imagine you’d lost the ticket instead of the money. Would you buy another ticket? If you really wanted to see the movie you would, but it would sting – 54% of the study participants said they wouldn’t. In logical terms the scenarios are the same, but there’s a massive emotional aspect in play.
5. You Fall For Anchoring
This bias is a favourite of salespeople because it allows them to manipulate price negotiations. Our brains rely too heavily on the first piece of information we receive when making decisions. At its simplest a salesperson can go in with a price higher than the item’s value in the knowledge that any price lower than that will be seen as a ‘win’ by the buyer. But it can also create confusion when choosing what to buy – if you decide early on that the buying criteria for a piece of hardware is its processing speed, you may fail to give enough weight to the features offered by a competing product, which could be more valuable than pure speed.
‘Give ‘boring’ and ‘glitzy’ data, as well as ‘quiet’ and ‘loud’ voices, equal weight’
6. It’s Vivid And Noisy, So You Engage
In our online age why do we still bother with showy, in-person presentations? Because they work. Another in-built human irrationality is called ‘vividness bias’. Psychologist Dr Steven Katz defines this as: ‘The tendency to overestimate the likelihood of the occurrence of something, just because it’s very salient or vivid.’ For example, he points out that most people who are afraid of flying are not afraid of travelling in cars. This is down to the vividness bias caused by infrequent plane crashes making headline news, while car crashes are so frequent that they’re mostly unreported.
‘So, we end up making decisions based on things that are very loud and visible even when they may not be very representative. A focus gets identified because a few people with loud voices think it’s important… But loudness is not a proxy for how much of something there is,’ says Katz. When making decisions give ‘boring’ and ‘glitzy’ data, as well as ‘quiet’ and ‘loud’ voices, equal weight.
7. You See Patterns In Random Data
We all like to think our actions and inputs have an impact. So when we start to review the success of a project, using data over time, and then do something intended to improve things, we actively look for patterns that show we’ve made a difference. If things don’t improve then we often change the input to try and get a positive outcome. The truth is that we’ve often fallen victim to randomness bias before we’ve even taken any action.
Take the example of incentives and punishments in a team of employees. Suppose you reward high performers with ‘carrot’ and punish the low performers with ‘stick’, then in the following month see the worst employees improve markedly while the high performers drop to just average. You might conclude that ‘carrot’ doesn’t work at all. But is part of this performance random? Are you reading a pattern that isn’t there, that just shows a regression to the mean, which would also happen if you spun a coin 10 times, got seven heads, then repeated it and got closer to five heads?
WHAT NEXT? Want to beat the unconscious biases of your brain, beyond just being aware of them? Well, most of them operate on irrational aspects of our thinking, so you can game your own responses by testing them with a set of logical questions before making financial decisions. These could include: ‘Can I afford this purchase?’, ‘Will this investment add value to my company,’ ‘Am I considering this just because of an amazing pitch or killer marketing?’
Another fail-safe would be to never make a decision entirely on your own, or entirely as a group. The first invites overconfidence bias, and the second risks groupthink bias. Get someone you respect to act as Devil’s advocate – the awkward questions are always the ones most worth asking!
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